Bank of Japan jack up interest rate to 0.5%

Discussion in 'Economics' started by Happy Hopping, Feb 21, 2007.

  1. Link from market watch

    The Bank of Japan faces a tough decision on whether to lift interest rates at the conclusion of its second policy board meeting of the year on Wednesday, as the economy continues to spin out conflicting signals.
    Recent economic data, including measures of quarterly gross domestic product growth and consumer consumption, suggest the world's second-largest economy continues on solid footing. However, disappointing wage growth and weak consumer prices point to an economy that some economists say may be too fragile to withstand higher borrowing rates.
    "The consumer price index and wages have been softening and it remains very difficult for the BOJ to justify a rate hike in a situation where inflation pressure remains quite limited," said Credit Suisse's chief Japan economist, Hiromichi Shirakawa. "As long as the BOJ looks at prices, a rate hike is premature."
    Bank of Japan Governor Toshihiko Fukui and others comprising the BOJ's nine-member policy board will vote on whether to lift the benchmark interest rate from 0.25% Wednesday.
    The board voted 6-3 to keep rates unchanged at its January meeting. If rates are raised, it would mark the second hike in borrowing costs since the BOJ ended its zero-percent rate stance in July of last year.
    According to Credit Suisse, the market is pricing in a 62% chance of a 25 basis-point rate hike Wednesday, up from a 61% chance Monday. The estimates were calculated using market-implied interest rate prices.
    Data released Thursday showed gross domestic product in the October to December quarter rose 1.2% from the previous quarter in price adjusted terms, or 4.8% on an annualized basis, the fastest rate of expansion in nearly three years.
    The data, which exceeded economists' expectations for a 3.9% gain, were driven by a surge in private consumption from low levels in the previous quarter owing to unseasonable cool summer weather. Private consumption grew 1.1% in the December-ending quarter, reversing a 1.1% decline in the July to September quarter.
    Despite the gains, economists caution the data were inconclusive when viewed in a broader context.
    "The rise of consumption simply reversed the decline of the previous quarter and spending was up only 0.6% year-on-year, still weakish" said Peter Morgan, chief Asia-Pacific economist for HSBC in an emailed report. "It (the GDP data) may not be enough to convince the BOJ to raise rates."
    Japan's core consumer prices rose 0.1% in December from a year earlier, slowing from a 0.2% rise in November, the government said last month. Consumer prices exclude fresh food prices.
    Morgan said the overall tone of the economic data made it likely he would raise his growth forecast for the Japanese economy in 2007. Morgan did not reveal any revised figures for the upgrade.
    The fourth-quarter GDP data brought Japan's real economic growth to 2.2% last year, up from 1.9% in 2005.
    The influential Nikkei newspaper reported Monday that Japan's ruling coalition parties have moderated their opposition to a rate increase in the run-up to the policy board's decision, in contrast to the indirect criticisms leveled prior to the January meeting.
    The business daily reported the more-distant stance is a nod to the central bank's independence and comes amid accusations the government and ruling coalition have been trying to influence monetary policy through political pressure.
    Despite relatively tame core consumer price inflation, analysts say the BOJ may be shifting its focus towards concerns of rapid asset-price inflation in some areas of the economy that could become a problem if monetary policy remains accommodative.
    "If the BOJ keeps interest rates too low for too long, something odd will happen in asset prices," said Maasaki Kanno, chief Japan economist for J.P Morgan.
    J.P Morgan forecasts the economy will expand 2.4% in calendar 2007 and 2.7% for the fiscal year.
    Kanno said the effects of the BOJ's easy money policy were already reflected in rapidly rising urban property prices, contractions in the yield on Japanese real estate investment trusts, and in the yen's slide against leading currencies. He added asset-price inflation was also fueling some froth in the stock market, although this was less of concern as there were few signs of a generalized bubble in the broader market.
    "As a risk manager, the BOJ should control the risk that may materialize in the future; this is a lesson that we learned from the 1980s when the BOJ maintained low interest rates for too long to prevent the yen from appreciating, but ended up with asset-price inflation," Kanno said.
    In its semiannual outlook report revised in January, the BOJ forecast Japan's economy will grow 2.1% in fiscal 2007.
    Japan has the world's second-largest economy behind the U.S. and one of the world's lowest interest rates. Those low rates have fostered a substantial yield spread with leading currencies.
    The BOJ benchmark rate of 0.25% has created a yield spread of 500 basis points with the U.S. and the U.K., and 600 basis points with Australia. The BOJ rate is also 345 basis points below the average rate set by the central banks of the Group of Seven leading industrialized nations.
    Economists say the yield differential is partly responsible for the massive yen carry trade and has helped send the Japanese currency to historical lows against leading currencies on a trade-weighted basis