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Fri, Mar 10, 2006 - Page 10 News List

Japan to tighten monetary policy

IMPROVING ECONOMY The market reacted positively to the news that the Bank of Japan plans to begin gradually moving away from its `quantitative easing' policy


The Bank of Japan yesterday abandoned the super-easy monetary policy it has kept for five years, saying it will gradually raise interest rates and start to cut the excess cash in the banking system amid signs of economic recovery.

But the central bank sent a clear message that the transition will be slow, saying benchmark interest rates will remain near zero for some time and that it will only gradually reduce the amount of liquidity in the banking system.

Economists praised the move as shrewd and balanced, saying the Bank of Japan was careful to take timely action without alarming global markets that had grown jittery in recent weeks about a possible end to the policy, which made it easy to borrow money in Japan practically interest-free.

"The bank did a splendid job," said Yasuhide Yajima, senior economist at NLI Research Institute in Tokyo. "The market had expected an end to the policy, but the bank still left interest rate rises open to interpretation."

The initial reaction from Japan's stock market was positive, with the Nikkei 225 index jumping 2.6 percent, relieving weeks of uncertainty and boosting confidence in the central bank's determination to move despite considerable political pressure to hold off.

The Bank of Japan had no easy task in timing and charting an exit from its super-easy policy.

The policy it had maintained for five years, known as quantitative easing, was unprecedented. The US Federal Reserve and the world's other central banks rely on interest rates to keep an economy in balance, including price fluctuations and growth.

But with the Japanese economy stuck in a decade-long slump and interest rates already at zero, the central bank flooded the banking system with money to spur borrowing and lending.

That policy finally seemed to be paying off with corporate profits growing, consumer spending rising and the overall economy growing at a 5.5 percent pace in the fourth quarter.

Still, Prime Minister Junichiro Koizumi and other politicians had urged the bank to proceed with caution, noting that the bank will be at fault if it's found later to have acted too hastily.

The bank also had to watch for indicators for deflation, a situation that is unusual for industrialized nations like Japan, the world's second-largest economy. Deflation saps an economy of its strength by eroding company profits, wages and growth.

The bank had said it wouldn't alter its policy until consumer prices, which have been falling for about seven years, started to rise again.

Recent data for January showed that a key index for consumer prices rose for the third straight month and marked its strongest increase since 1998.

Glenn Maguire, chief economist at Societe Generale in Hong Kong, said he expects the bank to hold off until December to start raising interest rates, but said the bank's decision had been more aggressive and bold than most economists had expected.

"It's unambiguously good news for Japan. It signals the dark days of deflation are behind us," Maguire said.

The one surprise that came in the bank's announcement was that board members in effect set a target for price increases, defining a flux of between zero and 2 percent in the consumer price index as desirable.

Some experts had opposed setting such numbers as robbing the central bank of its flexibility. Others had said that special factors such as surging oil prices could commit the bank to a price target that could backfire.

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