[B]INSIDE THE MARKETS
Bank of Japan plays waiting game on rates
By Hideyuki Sano ReutersPublished: September 1, 2008[/B]
TOKYO:
The Bank of Japan will probably leave interest rates unchanged through its first recession in six years and is unlikely to cut them unless a global financial crisis requires coordinated action from central banks.
The central bank has little choice but to sit tight, analysts say, since it has little control over the causes of the looming recession: high commodity prices and slowing exports. And with inflation at a decade high, a rate cut would be risky.
The Bank of Japan is expected to hold fire through what many economists expect will be a short, shallow downturn and eventually raise interest rates from 0.5 percent before inflation takes root in the economy.
“For the moment, there’s nothing they can do but to wait,” said Mari Iwa****a, chief market economist at Daiwa Securities SMBC.
The Japanese economy suffered its biggest contraction in seven years in the second quarter, shrinking 0.6 percent because of rising prices and slowing exports. That has raised worries that the economy is already in recession, or is close to slipping into one, for the first time since 2001-2002.
A rate cut would do little to reverse the rising price of oil and other raw materials, a trend due to strong demand in emerging economies, or the slowdown in the world’s major economies, which is curbing Japan’s exports.
A rate cut may help borrowers but would weaken the yen, and a weaker yen would increase prices of imported oil and other raw materials, which are already high.
“If they cut rates, that may just push the economy more to stagflation,” said Hideo Kumano, chief economist at Dai-ichi Life Research.
Annual inflation hit a decade high of 2.4 percent in July, nearly five times the Bank of Japan’s main policy interest rate of 0.5 percent.
The central bank has repeatedly said that its current policy is accommodative and that a protracted period of low interest rates could sow the seed of excessive investments.
According to the Taylor rule - a formula created by the economist and former U.S. official John Taylor to help central banks set appropriate interest rates - Japanese rates should be about 1 percent, said Junko Nishioka, economist at RBS Securities. The Taylor rule says nominal interest rates should exceed a country’s inflation rate, after averaging out short-term fluctuations.
From 2001 to 2006, the Bank of Japan carried out an unorthodox and super-easy policy, called quantitative easing, in which the central bank flooded the banking system with excess cash.
The bank has raised rates by a quarter percentage point twice since it abandoned the quantitative easing policy in early 2006.
Economists expect Japanese inflation to ease soon, given a recent retreat in oil prices, but they say it is not clear how far it will subside.
“There’s uncertainty over inflation,” said Seiji Adachi, senior economist at Deutsche Securities. “Companies have not fully passed on rising costs. And they often pass on the rise with a lag.”
A Bank of Japan board member, Miyako Suda, said Thursday that the bank could not relax its guard on inflation.
Although she is considered among the most hawkish on the central bank’s board, analysts think the view of the bank’s governor, Masaaki Shirakawa, may not be so different.
Some analysts think Shirakawa revealed a desire for higher rates when he misspoke and said at a media conference that the bank had kept interest rates at 0.75 percent, instead of the correct 0.5 percent.
“Some say it’s just a mistake, but I think we should read more into that,” said Jun Ishii, chief bond strategist at Mitsubishi UFJ Securities.
“I can say from my experience that you tend to say key words even without being conscious of doing so.”
Derivative markets have recently priced in a small chance of a rate cut later this year, but analysts say that has more to do with a quirk in traders’ positions in the illiquid market.
With not much room left for rate cuts, the bank’s remaining ammunition to stimulate the economy is likely to be kept for emergencies like as a meltdown in the global financial system.
“I don’t think the BOJ will cut rates unless they are asked to as a part of international policy coordination,” said Adachi, the senior economist at Deutsche Securities.
