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BOJ faced pressure over inflation goals

First-ever target expected to aid government in halting yen's rise

by Shinya Ajima

Kyodo

The Bank of Japan’s decision to announce its first-ever inflation target is being widely interpreted as the central bank stepping up its commitment to end chronic deflation.

But analysts say the move is also the result of political pressure and will benefit the government, which has struggled to address the yen’s historic rise and even been criticized by some countries over its market interventions.

Catching experts by surprise, the BOJ Policy Board on Tuesday unanimously voted to set a short-term target of 1 percent for consumer price inflation, following the practice of the U.S. Federal Reserve. Its members also voted to expand the bank’s asset purchase program by ¥10 trillion to ¥65 trillion in total.

Following the policy announcement, which led to a view in the market that the country’s eased monetary policy would continue for the coming years at least, the dollar rose to the highest level in more than three months, topping the mid-¥78 line in Tokyo on Wednesday morning.

“The market reacted to the BOJ’s decision,” said Osamu Takashima, chief foreign exchange strategist at Citibank Japan Ltd. “Now we have seen (the government and the BOJ) face a crucial turning point in policy, as they cannot let the yen keep appreciating as it has been.”

The yen surged to a postwar record of 75.32 to the dollar in late October, causing the Finance Ministry and the BOJ to intervene in the market amid fears that the negative effect on exports would slow economic growth.

The ¥9 trillion intervention, conducted from Oct. 31 to Nov. 4, was the third in a year and temporarily curbed the yen’s spike. But the dollar has resumed its fall in recent months, buttressing the market’s view that the intervention was largely ineffective.

Finance Minister Jun Azumi has repeatedly emphasized that the government is prepared to step into the market whenever it deems intervention is necessary, but according to a widely held view it won’t be easy in practice to keep intervening. The United States and some European nations have complained that Japan’s unilateral action could complicate efforts to encourage China to ease its monetary policy.

A senior government official described the BOJ’s decision as “good news,” adding the central bank’s move and the subsequent fall of the yen were in line with the government’s hopes.

BOJ Gov. Masaaki Shirakawa denied the Policy Board has bowed to any pressure from the government or lawmakers to introduce the consumer price index goal, which he had long suggested would hinder the bank’s control of monetary policy.

But while attending Diet sessions in recent weeks, Shirakawa was pressed by lawmakers to introduce a CPI target to ensure transparency in the bank’s monetary policy and to communicate its goals to market participants more clearly.

By explicitly stating an inflation goal, the BOJ hopes to convey its intentions more precisely to financial markets and “reinforce the effect of accommodative policy,” Shirakawa told reporters after the new policy was announced.

But analysts argue the BOJ sensed that if it didn’t take additional monetary easing steps and allowed the yen to appreciate much further, its independence from the government might come under threat.

“Most major central banks in the world are now biased toward easing their monetary policy. It is natural that the BOJ thinks it will be harmful if it does nothing, given the possible impact on the yen’s exchange rates,” said Masamichi Adachi, a senior economist at JPMorgan Securities Japan Co.

Hideo Kumano, chief economist at Dai-ichi Life Research Institute, expressed a similar view, saying the BOJ “is now caught in a race for monetary easing” with central banks in other major industrialized nations.

Last month, the Federal Reserve announced that it plans to keep interest rates at extremely low levels until at least late 2014, and set a formal inflation target of 2 percent. The European Central Bank has stepped up its response to the eurozone’s sovereign debt crisis and poured euros into the market, while the Bank of England last week expanded the size of its government bond purchase program to boost Britain’s economy.

The BOJ also decided Tuesday to buy an additional ¥10 trillion worth of Japanese government bonds from financial institutions under its expanded asset purchase program, a move to inject more liquidity into the banking system.

“This will gradually impact the foreign exchange market by easing the appreciation of the yen,” said Hiromichi Shirakawa, chief economist at Credit Suisse Securities (Japan) Ltd.

Shirakawa also believes there is a political dimension to the BOJ’s policy U-turn on inflation.

At a time when some lawmakers are seeking to revise the Bank of Japan Law to enable the government to exert more influence over the BOJ, Shirakawa said he expects that “such pressure will ease to some extent.”

Further inaction would only have hurt the BOJ’s relations with the government and could have given it grounds to intervene in the bank’s affairs, and possibly even in appointments to its Policy Board, which must replace two of its members in April, he said.