Faceoff in Japan

If you thought in the beginning of this week that a raise by the BOJ come tomorrow was a sure bet you should perhaps think about revising your views. The situation in Japan is a difficult one; ever since the BOJ ended its ZIRP policy back in June 2006 markets have more or less been expecting the transition towards a normalization process where the BOJ would be able to raise the interest gradually to take it off its current very low level of 0.25%. However, the economic data to support such a process has simply not been going the BOJ's way. It is not that Japan has not experienced economic growth but most of it has been driven by exports and this is the main issue here ... even though the BOJ ended ZIRP key economic data such as consumer spending and inflation figures simply have not supported the BOJ to go north.

However, the pressure is mounting on the BOJ to set off this normalization process and until the beginning of this week it was widely expected that the BOJ would raise at least one time in the beginning in 2007. Yet, as domestic political interests now are being mobilized as well as a function of the Japanese ministry of finance the BOJ is really caught between the proverbial rock and hard place.  

(from Bloomberg - bold parts are my emphasis)

The Bank of Japan faces a test of its credibility tomorrow after local media said policy makers will delay raising interest rates, spurring concern they are bowing to government pressure.

Bonds rose the most in almost four months and the yen fell to a 13-month low after Kyodo News, the Nikkei newspaper and NHK Television said the central bank will likely keep its benchmark rate at 0.25 percent. Ruling Liberal Democratic Party Secretary General Hidenao Nakagawa said on Jan. 14 that the government should request a policy decision delay.

Governor Toshihiko Fukui risks appearing to yield to political opposition, hampering his plan for gradual rate increases to head off a repeat of the 1980s asset bubble that triggered a decade of stagnation. The government is concerned that a rise in borrowing costs would exacerbate a slump in consumer spending.

``This is a shame and disgraceful,'' said Tomoko Fujii, senior economist at Bank of America N.A. in Tokyo. ``Can't they trust their own central bank? This kind of thing never happens in the U.S. and Europe.''


Japan's households became the most pessimistic they've been in a more than year in December after wages fell, the Cabinet Office said today. The report signaled consumer spending may be slow to rebound after declining at the fastest pace since 1997 in the third quarter.

The FT also has the story and highlights the strenuous relationship between the BOJ and the domestic political scene.

The Bank of Japan began a two-day policy board meeting Wednesday amid intense political pressure not to raise interest rates.

In recent days, bank officials have, through speeches and background comments, prepared markets for a possible rise in the overnight call rate from 0.25 per cent to 0.5 per cent. That has elicited a strong counter-offensive from the administration of Shinzo Abe, prime minister, which says it is premature to raise rates before Japan has definitively escaped from deflation.


Local media quoted unnamed sources Wednesday suggesting the BoJ might be willing to hold off raising rates. The bank is in a blackout period and strictly forbidden from making any comment.

Overnight swap futures immediately reacted, suggesting there was a 40 per cent chance of a rate rise Thursday against the 80 per cent likelihood they were factoring in a few days ago. The benchmark 10-year Japanese government bond rose, pushing the yield down 6bp to 1.675 per cent. The yen weakened to a 13-month low of Y120.80 against the dollar.

Jesper Koll, economist at Merrill Lynch, said: “This is a blackout period. The BoJ should launch an investigation into how this got out.” He added: “If the BoJ doesn’t raise rates [Thursday], they’ve clearly caved in to political pressure and have given control [of monetary policy] to the politicians. They have lost control of the debate.”

Of course this is a lot about communications and essentially how the BOJ is in fact and most definitely caught between a rock and a hard place. We all want and need to see a raise but what if expectations are just off here? I mean, would it be so hard just to state the obvious here and look at the fundamentals which simply don't merit a raise at this point. Moreover, we need to ask ourselves what really is the key to the Japanese economy at this point and then I believe we could begin to let expectations correct to the much allured fundamentals. Lastly, I want to point you to the aggregate blog of me and Edward Hugh's posts on Japan which pretty much has been predicting this a year now; so expectations have not been off all over the board it would seem.

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