Japan Economic & Monetary Policy Trend

1. Economic Development
   
2. The Monetary Policy
   
3. The Foreign Exchange Market
   
4. The Equities Market
   

 

Economic Development/Monetary Policy

Japan's decade-long fight against deflation may be over, only to be replaced by inflation that is sapping economic growth.

Central bank Governor Toshihiko Fukui has been predicting the economy's longest expansion in more than 60 years will spur profits and feed into wages and consumer spending, leading to steady price gains. Instead, prices are being driven by increasing oil and raw-materials costs, which is hurting profits and wages and eroding household spending power.

After waiting so long, the Bank of Japan may well end up with the wrong sort of inflation. Rising energy and food prices are bad news for firms and consumers and will provide a further headwind at a time when Japan already has to contend with a sharp slowdown in the U.S.

Consumer prices, excluding fresh food, rose 0.8 percent in December 2007, the fastest pace in more than nine years and double November's 0.4 percent. Prices had been falling as recently as September 2007.

Cost-driven inflation coupled with slower economic growth may make it more difficult for the central bank to implement its policy of gradually raising interest rates.
Higher oil and commodity costs, while putting pressure on consumer prices, are squeezing profits and weighing on growth.

Since July 2006, when he ended a policy of keeping borrowing costs near zero, the BOJ has argued that rates need to rise to reflect an economy that recovered from three recessions following the bursting of the stock- and property-market bubbles in the early 1990s. The bank last increased its benchmark overnight lending rate, to 0.5 percent, in February 2007; that's still the lowest among major economies.

A cut now (Jan 2008) would become a realistic option if the jobless rate starts rising and wages keep falling. Policy makers would have to be more worried about the economy rather than inflation.

Japan's unemployment rate stayed at 3.8 percent in December 2007, the government statistics bureau said today. The ratio of jobs available to each applicant fell to a two-year low of 0.98. Retail sales slid 0.1 percent in 2007, the first decline in five years.

Meanwhile, workers' pay is falling as Japan's export-led economy loses steam. Average wages slid in nine of the first 11 months of 2007 and have slumped 11 percent, or 500,000 yen ($4,700), since 1997.

With consumer confidence at a four-year low, companies are finding it hard to pass on higher costs.

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A leading contender to succeed Bank of Japan Governor Toshihiko Fukui said Japan's economic slowdown was expected to continue for some time, reinforcing views that the central bank will wait at least until late in 2008 to raise interest rates.

BOJ Deputy Governor Toshiro Muto, a former finance ministry bureaucrat who has rarely strayed from the bank's official line, also said downside risks to the global economy were heightening, although he reiterated that the central bank's next move would still be to raise interest rates, not cut them.

Surging raw material costs, sharp falls in Japanese housing investment and growing uncertainty in the global economy have led to a slowdown in Japan's economy, which had been expanding only modestly in the first place.

The positive cycle of output, income and expenditures is weakening temporarily but do not think the mechanism itself will break.

Muto said that the central bank has not fundamentally changed its main economic scenario of gradual economic expansion, and thus its basic monetary policy stance. But the bank's scenario was based on a forecast of economic conditions, which was not immune to changes depending on how downside risks develop.

Financial markets' reaction was muted as Muto's remarks did little to change the widespread view that growing threats to Japan's economic outlook will keep the BOJ from raising its key policy rate from 0.5 percent until late 2008 or even next year.

So there is no change in the BOJ's basic stance on monetary policy, that the BOJ will adjust interest rates as the economy steadily grows. He stressed downside risks to the economy, but that is in line with BOJ Governor Fukui, who mentioned those risks in November and December 2007.

Fukui, whose term expires in March 2008, has repeatedly said the BOJ needs to raise rates from current low levels to prevent a distortion in asset allocation from destabilising the economy.

The BOJ downgraded its economic assessment in Dec 2008, the first such major downgrade in three years, saying growth was slowing. But it has stuck to its view that rising output would boost household income and spending, keeping the economy on track for steady growth. This thinking has been the rationale for the BOJ in arguing that interest rates would need to be raised from current low levels.

The central bank has kept rates on hold since it raised them by a quarter percentage point to 0.5 percent in February 2007, and many in the market see no BOJ move in the coming months (Jan 2008 & Beyond).

A monthly survey by the Economic Planning Association, a Japanese government-affiliated body, showed on Thursday that a majority of economists expect the BOJ to keep rates on hold at least until July-September 2008, with 21 of 33 who responded anticipating a rate hike during the third quarter 2008. None saw a rate move by April 2008.

Muto cautioned that sustained growth in the global economy, which was key for Japan's economy to move in line with the BOJ's basic scenario, was facing growing downside risks. The U.S. economy was slowing further and conditions could worsen if prolonged adjustments in its housing sector begin to hurt personal consumption and capital expenditure. Downside risks for the global economy are heightening as adjustments in the U.S. economy and global financial markets deepen.