Outlook: Japan

IT WOULD hardly be possible for Japan to cut short-term interest rates any further than it did yesterday. At 0.25 per cent for overnight money, Japan is perilously close to the position where depositors will have to pay the banks for the privilege of lending them money.

With the yen strengthening in recent months, the Central Bank of Japan took the opportunity to cut the call rate to the lowest level that can be achieved in nominal terms without moving into the Alice in Wonderland world just outlined. Because prices are falling in Japan, real interest rates are still quite high, of course, so the effect of the change is unlikely to be any more than marginal.

Still, with Japan in a state of political paralysis, there are very few things the authorities can still do to stimulate demand. With yesterday's cut, they used up the one remaining option. As the first easing in monetary conditions in Japan for three years, this is undoubtedly an important signal, but it seems doubtful it amounts to much else.

The cost of money is not the reason Japan's economy is sinking. That's got much more to do with the very serious nature of its banking crisis, made that much worse by economic meltdown in the rest of the Far East. If Hong Kong were to go too, it's hard to see how the system could maintain any remaining vestige of credibility, such is the exposure of Japanese banks to the former colony's property market. A very large part of the Japanese banking system would have to be closed.

And tempting though it might be for markets to regard the cut as just the first in a general easing of rates throughout the developed world, don't count on it. It is still odds on that the MPC won't cut UK rates at the end of its two day meeting today, and the chances of the Fed cutting rates soon look even more remote.