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Central Bank Makes First Rate Hike in 10 Years

September 19, 2000
The Bank of Japan's Policy Board voted on August 11 to lift its 18-month-old zero-interest-rate policy of guiding unsecured overnight call rates to zero. The board voted seven to two to raise the target for the rate banks charge each other to 0.25%. While the official discount rate was left unchanged at 0.5%, the lifting of the policy represents the central bank's first effective rate hike in 10 years.

The decision was made in the light of improvements in corporate earnings and plant and equipment investment, which led most Policy Board members to conclude that deflationary concerns have been dispelled, the condition the board had set for lifting the zero-interest-rate policy. The administration of Prime Minister Yoshiro Mori pushed strongly for a continuation of the policy, but a request from the board's government representative to postpone a hike for another month was voted down.

The termination of the zero-rate policy has caused interest rates on bank deposits and loans to edge up slightly, but its impact on economic activity as a whole has been minimal.

Dispelling Deflationary Concerns
The zero-interest-rate policy was implemented by channeling ample funds into the interbank money market so as to steer the overnight call rate to zero. It was instated in February 1999, when the Japanese economy was in danger of becoming mired in a deflationary spiral of plummeting consumer prices and deepening recession. In lifting this policy, the BOJ emphasized that it was merely normalizing an abnormal measure instituted to address an extraordinary situation.

In July, when the Policy Board opted to postpone a vote on the zero-rate policy for a month, it cited the need to ensure the firmness of economic conditions, including employment and household income. Figures released since then showed that unemployment in June declined for the second straight month and that the semiannual employee bonuses paid in June increased for the first time in four years. Most board members thus concluded that both employment and household income were recovering.

The administration and the ruling parties strongly resisted raising interest rates, insisting that the recovery was still unassured and that higher rates would stifle nascent growth. At the August board meeting, too, the government representative objected to lifting the zero-rate policy and appealed to other members to put off a vote for another month. This request was rejected by a majority vote.

In a statement released after the policy meeting, the BOJ noted that "Japan's economy is showing clearer signs of recovery," a more progressive statement than its earlier stance that "Japan's economy is recovering gradually."

Continued Support for Economic Growth
Since autumn 1997 the financial sector has been rocked by a series of major bankruptcies and a debilitating credit crunch, prompting the BOJ to take the unprecedented step of providing money without interest. As a result, the fund procurement costs of private banks declined, providing them with bigger profit margins over the interest offered on deposits and charged on loans.

The leeway allowed banks to write off some of their bad loans and stabilized the financial system. Stronger signs that the economy was recovering appeared, as corporate earnings and capital spending continued to improve, and the rejuvenation of the corporate sector began to be reflected in higher household consumption as well.

While there is still downward pressure on retail prices, the BOJ maintains that this is due to technological innovations in the information and communications industries and changes in the distribution structure--not from weak demand. Most Policy Board members agreed in voting to lift the zero-interest-rate policy that deflationary concerns in the Japanese economy has been dispelled.

Financial institutions have been setting slightly higher interest rates on deposits and loans, but because the margins have been minimal, the impact of higher rates has been negligible. For construction, real estate, and distribution firms with massive debts, though, even a slight rise in the cost of capital could inflate their repayment burdens, and some say this could slow a full-scale recovery.

The BOJ stresses that it will maintain an easy money policy, and Prime Minister Mori has announced he will begin work on formulating a supplementary budget. Both fiscal and monetary measures, therefore, will continue to be employed to bolster the recovery.

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Trends in JapanCopyright (c) 2000 Japan Information Network. Edited by Japan Echo Inc. based on domestic Japanese news sources. Articles presented here are offered for reference purposes and do not necessarily represent the policy or views of the Japanese Government.