Bank of Japan to maintain low interest rates

Tokyo : The Bank of Japan (BOJ) said it would not tolerate zero inflation or falling prices and reinforced its commitment to maintain very low interest rates, setting the scene for further easing of monetary policy to fight deflation.

The BOJ's most aggressive statement on deflation since the end of quantitative easing in 2006 sparked a surge in bond prices to factor in the risk of fresh policy action, such as expanding a new funding operation or increasing government bond purchases.

The commitment to fight falling prices also marks the central bank's second significant response in a matter of weeks to government pressure to help prevent deflation from tipping the economy back into a recession, after it offered short-term funding at an emergency meeting on December 1.

While Governor Masaaki Shirakawa said the BOJ wasn't committing itself to ease policy further, failure to follow through with a clear plan to beat deflation may put its credibility on the line, especially since Japan has been in deflation for much of the past decade anyway.

"There had been the view that the BOJ was too optimistic about the outlook for the Japanese economy and the state of deflation, and markets had thought the BOJ might tolerate deflation.

"But it made clear that it doesn't, so that was good," Susumu Kato, chief economist at Calyon Capital Markets Japan, said.

"But people may start having doubts about the credibility of the BOJ's stance unless it makes clear how it will cope with deflation."

In contrast

As widely expected, the BOJ left its policy rate at 0.1 per cent, a level that analysts forecast could stay unchanged until 2012 given deflationary pressures, in contrast to other major central banks which are expected to start raising rates later next year.

The lead March 10-year Japanese government bond futures finished near a 20-month high, while the five-year bond yield hit a four-year low of 0.445 per cent.

The two-year JGB yield also fell one basis point to 0.160 per cent, near a four-year low hit earlier in the week.

The BOJ has forecast at least three years of deflation, a consequence of Japan's longest recession since World War Two which ended earlier this year.

"This shows that the direction is at the very least toward a continuation of monetary easing, and also suggests there is the chance that monetary easing may be strengthened," Naomi Hasegawa, senior fixed income strategist for Mitsubishi UFJ Securities, said.

The BOJ changed its definition of long-term price stability to show that it refuses to tolerate not only deflation but now flat consumer prices.

Previously it had described price stability as consumer price growth of zero to two per cent.

First change

It was the first change to a definition the BOJ first applied in March 2006 to show its policy stance after ending quantitative easing following a bout of deflation for much of 1998 to 2006.

"It seems the BOJ wanted to get zero out of their price understanding.

"They're trying to show that they are going all out to stop deflation," said Adrian Foster, head of financial markets research at Rabobank International, Hong Kong.

"This is aimed at reinforcing that the BOJ and the finance ministry are in sync and that they don't want a stronger yen because of deflation."

Consumer prices have been falling for most of this year compared with year-earlier months. Data next week is expected to show that closely watched core consumer prices in November fell 1.7 percent from a year earlier.