BOJ finds that manipulating rates is packing little punch

by Shinya Ajima

Kyodo News

The Bank of Japan’s move Tuesday to support corporate finance may stem from its concern that extremely low interest rates are not stimulating the economy amid the financial crisis.

Lower borrowing costs are usually believed to improve liquidity in the financial system and boost economic activity. However, given the global credit turmoil, banks and other financial institutions are increasingly cautious about extending fresh loans to companies for fear of defaults.

Financial conditions in Japan “seem to have become less accommodative . . . in terms of availability of funds,” BOJ Gov. Masaaki Shirakawa told business leaders at a meeting in Fukuoka Prefecture on Monday. “The risk that the effects of the (BOJ’s) current low interest rates may not permeate through the economy is increasing.”

Some of the meeting’s participants said the BOJ is focusing solely on macroeconomic development and called for the central bank to place priority on the difficulties facing smaller businesses in regional economies.

Shirakawa implicitly rejected the criticism, stressing the BOJ is always considering micro as well as macro conditions.

Akira Maekawa, senior economist at UBS Securities Japan Ltd., said the emergency measures unveiled Tuesday suggest “the BOJ is finally realizing the tough environment surrounding small and midsize companies. The move is expected to help ensure a smooth flow of funds within the economy.”

The BOJ has maintained its key interest rate at 0.3 percent after reducing the rate from 0.5 percent in October, its first cut in more than seven years. The rate compares with 1.0 percent in the United States, 3.25 percent in the euro zone and 3.0 percent in Britain.

The BOJ managed its policy rate at abnormally low levels in the past decade while steering the country’s financial system through the gloom of the last recession — occasionally setting the rate at near zero and even introducing the ultraloose quantitative easing policy with ample liquidity injected into the system.

But recently the BOJ has showed reluctance to tread the same path of credit easing only for the purpose of stimulating the economy.

If interest rates are lowered too much, “interest income will not be able to cover the cost of various deals, and as a result, trading volume in financial markets could get smaller while market liquidity could dry up,” Shirakawa said last month.

While calling attention to both the positive and negative impact of rate cuts, the governor told reporters Monday, “Given extremely low interest rates, there is a possibility that various problems could occur in terms of securing a smooth functioning of financial markets.”

Osamu Takashima, chief market analyst at the Bank of Tokyo-Mitsubishi UFJ, suggested the BOJ can no longer use cuts in interest rates as a method to control financial markets.

“I doubt there is any fundamental meaning in cutting an interest rate of 0.3 percent to zero,” Takashima said.

Hideo Kumano, chief economist at the Dai-ichi Life Research Institute, echoed this view, saying that cutting the rate further could only “kill the function of the market mechanism.”

“The fact that the BOJ takes action in this phase and without shifting interest rates amounted to a certain surprise for market participants,” Kumano said.

He also said the BOJ showed it wants to “encourage participants in interbank borrowing markets to take risks again.”