How To Know If The Boj Will Change Its Zero Interest Rate Policy

Transcription

1 NO.12 July 2006 BOJ ends Zero Interest Rate Policy The Bank of Japan (BoJ) decided to end its zero interest rate policy on Friday, July 14. This report will give an overview of the decisions announced and our outlook for monetary policy based on them. 1 Summary of Changes in Monetary Policy (see Table below) Changes in the guideline for money market operations (Summary of Changes) The target rate for the uncollateralized overnight call rate was changed from effectively zero percent to around 0.25 percent. The official discount rate (the basic loan rate) was raised from 0.1 percent to 0.4 percent. (Provisions for money market operations) Outright purchases of long-term interest-bearing Japanese government bonds will continue at the current amounts and frequency. With respect to the basic loan rate of the complementary lending facility, the temporary waiver of add-on rates for frequent users of the facility will be maintained. The BoJ ended its zero interest rate policy that lasted for five years and four months since March 2001 by deciding, on a unanimous vote, to change the target rate for the uncollateralized overnight call rate from effectively zero percent to around 0.25 percent, effective immediately from the announcement of the decision. The last time the BoJ performed a rate hike was almost six years ago in August

2 The official discount rate was also raised from 0.1 to 0.4 percent. Market expectations on how much this official discount rate would be raised had ranged from 0.35 to 0.5 percent, and the Bank s decision was for a modest increase. The current role of official discount rate (Note 1) is to serve as the ceiling rate that controls the short-term market interest rate. The spread between the official discount rate and the target rate for the uncollateralized overnight call rate had been kept at 0.1 percent. The rate hike will widen the spread to 0.15 percent, allowing for slightly more fluctuation of short-term market rates (Figure 1). The official discount rate was decided on a 6-3 vote. It is believed that some members had supported a raise to 0.5 percent to allow further fluctuation in the market. (Note 1) Changes in the official discount rate used to directly link to fluctuations in bank lending rates and interest rates on deposits. The official discount rate is now applied to the basic loan rate for the complementary lending facility the BoJ introduced from March (In order to facilitate monetary operations for smooth functioning and stability of financial markets, a standby lending facility ( Lombard-type lending facility) was introduced through which the Bank extends loans at the requests of counterparties under conditions pre-specified by the Bank.) If short-term interest rates (uncollateralized overnight call rates) rise in financial markets due to a particular event such as a quarter-end, the BoJ extends this loan at the official discount rate and thereby prevents the interest rate from fluctuating beyond that level. In its announcement last week, the BoJ changed its use of terminology and referred to this rate as the basic loan rate instead of the previously used official discount rate, aiming to avoid the impression that this is the representative policy rate. % 0.8 Figure 1: Uncollateralized Overnight Call Rate and Official Discount Rate Uncollateralized Overnight Call Rate Official Discount Rate July 14 - Monetary Policy Changed Source: Compiled by BTMU Economic Research Office based on Bloomberg data Year In the announcement released Friday, the BoJ explained the reason for its policy change as follows: The stimulus from monetary policy has been gradually amplified against the backdrop of steady improvements in economic activity and prices, and in this environment, maintaining the previous level of the policy interest rate may result in 2

3 large swings in economic activity and prices in the future. On the other hand, the Bank maintained its view on near-term monetary policy, stating that an accommodative monetary environment ensuing from very low interest rates will probably be maintained for some time, while it will adjust the level of the policy interest rate gradually in the light of developments in economic activity and prices. Government officials (from the Ministry of Finance and Cabinet Office) sitting at the Policy Meeting did not exercise their rights to request a postponement of the vote. The response from government seem fairly calm, as seen in Chief Cabinet Secretary Abe s comments on Friday that he felt the Bank was aligning itself with the governments economic policies. 2 Background of the Policy Change The BoJ decided to lift its zero interest rate policy because trends in the economy and prices were improving along its scenario. In the July Monthly Report of Recent Economic and Financial Developments the Bank made an interim assessment of its outlook released in April. It concluded that developments are broadly in line with the projection in our (April) Outlook for Economic Activity and Prices (the Outlook Report). The Bank had been expressing its concerns for prolonging zero policy rates from a while ago, as seen in Governor Fukui s comments about the upside risks of economic growth which may gradually increase if the policy rate were to remain unchanged (upon releasing the Outlook Report on April 28). It had also made its position clear that if the economy were judged to be moving along the Bank s outlook, the Bank would naturally reach a judgment at some point that the economy would be able to secure a more favorable sailing pass if interest rates were adjusted. The Tankan (short-term economic survey of enterprises in Japan) released on July 3 showed that corporate sentiment remained overall firm even amidst the stock market decline and rising oil. In addition, plans for business fixed investments marked the highest growth for this time of year since the bubble period in the 1990s, confirming the resilience of the current economic expansion (Figure 2). As the expansionary tone of the economy continues uninterruptedly, the sense of shortage in capacity and employment is growing stronger. The sense of shortage at this level has not been seen since the bubble years, meaning that the supply-demand gap is starting to tighten (Figure 3). Under these conditions, it is not surprising that the upward pressure on prices is gradually surfacing, even if at a small level (Figure 4). This means that economic activity levels have already geared up a notch from when the BoJ lifted quantitative easing in March this year, and the Bank is likely to have made the decision to adjust interest rates accordingly. 3

4 10 Yoy,% Figure 2: Business Fixed Investment Plans Note 1. Business fixed investment includes land purchases but excludes software investment. Fiscal Year 2. Data uses June survey results for chronological comparison, and differs from actal figures for busines fixed invesment. Source: Compiled by BTMU Economic Research Office based on Bank of Japan "Tankan" survey ("Excessive"- "insufficient", % points) -40 Figure 3: Production Capacity and Employment Conditions DI Insufficient Supply Excessive Supply Notes 1: Graph represents the weighted-average of production capacity DI and employment conditions DI reported in Year the BoJ "Tankan" survey. Weighted average is based on average number of employees and amount of capital stock (from 1980 to present). Seasonally adjusted by BTMU Economic Research Office. 2: Data for 2003 third quarter and earlier are based on former standards. Source: Compiled by the BTMU Economic Research Office, based on BoJ "Tankan" and MIC"Consumer Price Index" % Figure 4: Consumer Price Index CPI General (excluding fresh foods) CPI General excluding individual factors Year Note: 1. Included in individual factors are fresh foods, rice, fresh meat, petroleum products, telephone charges, electricity, gas (manufactured & piped), medical treatment, and cigarettes. 2. CPI General Index has ±0.1% deviations monthly from rounding off raw figures. "CPI excluding individual factors" modify these deviations. Source: Compiled by the BTMU Economic Research Office based on Ministry of Internal Affairs and Communiactions, Consumer Price Index 4

5 Stock prices, just recently turning weak again, did not prevent the BoJ from performing the rate hike. Until recently, the Bank had maintained the stance that financial market developments continue to warrant careful monitoring since they influence economic activity through their impact on business and household sentiment (commented by Governor Fukui on June 15). However, Governor Fukui explained on Friday that in their final assessment, the Bank felt the global stock decline is not a warning for future outlook. 3 Outlook for Monetary Policy The next question is the outlook for monetary policy and financial markets. We continue to support our previous forecast the BoJ will raise the policy rate one more time during the year and sustain rates at that level thereafter even after Friday s announcement. An important point we should keep in mind is that real interest rates still remain negative after this rate hike (Figure 5). The real interest rates is the nominal interest rate, less inflation (rate) which is a very useful concept when looking at how interest rates will affect the economy. If we calculate the current real interest rate based on the uncollateralized call rate (0.25% after the rate hike) and consumer price index (+0.6%), the interest rates are still at historically low levels. By looking at developments in monetary policy through the concept of real interest rates, it becomes clear that just ending the zero interest rate policy would not be enough to eliminate the risk in which the stimulative effects of monetary policy are amplified. % Figure 5: Real interest rates Real interest rate (Nominal interest rate CPI) Nominal interest rate (uncollateralized overnight call rate) YoY rate of changes in CPI (excluding fresh food, on a nationwide basis) 1.0 Outlook Note: 1. Uncollateralized overnight call rates until 1999 were quarterly moving average rates. Year 2. Rise in consumer prices caused by the hike in consumption tax to 5% implemented in 1997 were adjusted by BTMU Research Office Source: Compiled by the BTMU Economic Research Office based on BOJ Financial and Economic Statistics Monthly, Ministry of Internal Affairs and Communication Consumer Price Index 5

6 Current economic activity and price increase rates are at a higher level than the previous time the BoJ abandoned its zero interest rate policy in August 2000, and are even comparable to the levels in 1998 when the uncollateralized overnight call rate was at 0.5 percent (Figures 3 and 4). These trends in the economy and prices also show that it would not be surprising for the BoJ to judge there is still room for additional rate hikes. In the press conference following Friday s Monetary Policy Meeting, Governor Fukui said that the Bank will adjust the level of the policy interest rate gradually. We have seen an increase in comments by various BoJ officials that its approach to future rate hikes will be gradual (Note 2). Based on our observations above, we do not feel that they point to an intentional postponement of the second rate hike. These comments should rather be understood as checks against speculations on multiple or serial rate hikes such as expectations for six rate hikes in the next two years to spread in the market at this point. (Note 2) Other than Governor Fukui, there have been comments by officials such as Policy Board Member Mizuno saying in an interview that one of the important issues after the termination of the zero interest rate policy is avoiding speculations for serial rate hikes to become too strong (in the markets). One of the concerns in the outlook is the developments in the domestic and overseas economy. Growth in the OECD leading economic indicators have been sluggish for two consecutive months (change from previous six months, Figure 6) and it would be difficult to say that stock markets in the world have already recovered from the global downturn. Should factors such as a slowdown in the global economy leading to slowing of exports cause the Japanese economy to decelerate beyond our projections and fall into another temporary lull, the BoJ would not be able to perform additional rate hikes even if risks of economic overheating in the future still existed. We must closely observe the course of overseas economies the US in particular and whether Japan s economy will show any signs of heading to such a plateau. Change from previous half-year, %) 10 Figure 6: OECD Leading Economic Indicators Source: Compiled by BTMU Economic Research Office based on Bloomberg Data (Year) 6

7 4 Outlook for short- and long-term market interest rates Short-term market interest rates (on TIBOR, FB, etc.) are expected to maintain an underlying upward trend, as there is more possibility for a rate hike than a rate cut in the outlook for monetary policy. It is also unlikely for rates to rise rapidly, forming a steep curve. This is because short-term rates have already risen to a level that factors in Friday s rate hike. Looking at the three-month TIBOR for example, recent rates are already above the level at the time the BoJ previously raised its zero policy rate to 0.25 percent in August 2000 (Figure 7). The graph also shows that rates are rising at a more gradual and constant pace compared to 6 years ago. This suggests that the short-term interest rate markets have smoothly factored in the end of the zero interest rate policy. BoJ s decision on the official discount rate a relatively small increase but still within market expectations of 0.35 to 0.5 percent; is also expected to have some effect in containing volatility and controlling the upward pressure on market rates. We therefore expect the rise in market interest rates to be limited in the coming weeks following this rate hike. We also foresee a fairly limited impact on long-term market interest rates. Rather than this widely expected shift in monetary policy, the markets are concerned about the timing and extent of subsequent rate hikes, and most importantly, the developments in domestic and overseas economies which are already flagging some signs of slowdown. We believe that after rising up to around two percent in the near-term, long-term interest rates will temporarily weaken towards the year end as the slowdown in growth of overseas and domestic economies gradually surface. % 0.5 Figure 7: Three-month TIBOR Zero Interst Rate Policy Ended 0.4 Previous termination of zero-rate policy 2000 August 0.3 Termination of zero-rate policy 2006 July ± Number of business days from zero interest rate policy termination Source: Compiled by BTMU Economic Research Office based on Bloomberg data July 14, 2006 Yoshito Mori 7

8 For further details, please contact the Economic Research Office (Chief manager Fukaya) Tel: This report is intended only for information purposes and shall not be construed as solicitation to take any action. In taking any action, each reader is requested to act on the basis of his or her own judgment. This report is based on information believed to be reliable, but we do not guarantee its accuracy. The contents of the report may be revised without advance notice. Also, this report is a literary work protected by the copyright act. No part of this report may be reproduced in any form without express statement of its source. This report is also available for viewing online at 8