Bank of Japan ends super-loose monetary policy

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The Independent Online

Japan's central bank took a leap into the economic dark yesterday by ending a five-year policy of zero interest rates, ignoring government warnings that the shift could harm the country's fledgling recovery.

The bank's board voted seven-to-one after a two-day meeting to abandon the policy, introduced in March 2001 to help fight the deflation that had crippled the world's second-largest economy for years.

The Prime Minister Junichiro Koizumi said yesterday he "respected" the Bank of Japan's decision, despite earlier expressing reservations - along with the policy chief Hidenao Nakagawa and other ministers - about tightening credit. "There are signs of an impending end to deflation, but we cannot say we have already escaped it," Mr Koizumi told policymakers before the BOJ meeting, adding that "a return to square one" on the deflation problem was "inadmissible".

The markets welcomed the move, widely seen as further confirmation that the economy is finally on the mend. The Nikkei closed up 409 points to 16,036.9, its highest position since the end of last month.

Hiroshi Okuda, the head of Keidanren, Japan's biggest business lobby group, endorsed the shift to tighter monetary control, predicting it would have "no major adverse impact" on the economy. The finance minister Kaoru Yosano said the decision was "in line" with the government's aim of ending deflation by the end of fiscal 2006.

With unemployment down, consumer spending up and the current account growing steadily, the BOJ move was widely forecast. The economy is expected to grow by almost 2 per cent in real terms in fiscal 2006. Consumer prices in January rose 0.5 per cent, the fourth straight monthly increase, meaning the conditions that spawned the unorthodox super-loose monetary policy have officially ended.

The central bank said in a statement released with the latest announcement that conditions are in place for "a sustained recovery."

But several members of the government wanted the central bank to wait until the end of next month before tightening credit, fearing that ending the policy too soon would snuff out Japan's best hopes for lasting recovery since the collapse of the bubble economy in the early 1990s. The prospect of higher interest rates also spooked foreign investors worried that turning off the cheap cash in Japan would choke off the flow of investment to the US and other economies.

The BOJ governor Toshihiko Fukui brushed off these fears, saying the board was "in agreement" that it would have been "irresponsible" to postpone the decision. Mr Fukui and the board of the BOJ, which was given more autonomy to determine monetary policy in the late 1990s, were wary any delay would signal to markets they had surrendered their newly won independence to government pressure.

The easy-money policy flooded the economy with cash in an attempt to stoke borrowing and lending, initially setting a liquidity target of ¥5 trillion (£24bn). But this had ballooned to ¥35 trillion by 2004, generating alarm that such an excess of cash in a recovering economy could fuel another property and stock bubble.

The BOJ acknowledged government concerns by hedging its bets on the prospect of rising interest rates, pledging to hold them at "near zero" for the time by, for example, holding the unsecured overnight call rate near zero and continuing a policy of monthly purchases of ¥1.2 trillion in long-term government bonds. Mr Fukui said: "Interest rates will stay at zero for some time, then stay extremely low and go through an adjustment period. It's up to the economy how much and when."

Analysts in Tokyo predicted the bank would wait until the end of the year before raising rates. But others suggested the government members who regret ceding so much authority to the BOJ had given it just enough rope to hang itself. "Should the economy deteriorate, the government will put the strongest pressure yet on the bank and in effect bring it under its complete control," one analyst told Kyodo News yesterday.

The main dispute among the eight policy board members during the meeting is reported to have been over an acceptable rate of inflation, with a "reference rate" of 0-2 per cent eventually agreed as a compromise.

The former fiscal policy minister Heizo Takenaka called the board's decision not to set a numerical target for consumer price rises "extremely regrettable." Mr Fukui said the BOJ's approach would ensure "transparency" and "mobility."

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