BOJ raises reserves, guides rates near zero

BOJ Governor Masaru Hayami says the move amounts to quantitative easing

By Staff and wire reports

TOKYO, Japan -- Japan's central bank on Monday hiked bank reserves to shore up its ailing national economy effectively pushing interest rates back to zero.

The unusual strategy cuts rates -- the cost of borrowing money -- by pumping money back into the system. It marks a change from the normal approach of targeting interest rates.

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The Bank of Japan (BOJ) said at a meeting of its policy board it is abandoning its focus on the overnight call rate instead raise the amount of cash in its current account by 1 trillion yen.

A "strong" move

The shift in approach pushes rates back to zero, in an attempt to spark borrowing and revive economic growth.

"That's an extremely aggressive and strong move," said John Richards, Japan strategist with Barclays Capital in Tokyo.

The BOJ's action injects a large amount of money into the Japanese economy.

BOJ governor Masaru Hayami told a press conference that the switch to focusing on money supply amounts to quantitative easing. The BOJ also said it would keep that strategy until deflation stopped. Business interests had called for both quantitative easing and inflation targeting.

The BOJ's overnight reserves will increase to 5 trillion yen, or $41 billion, from 4 trillion yen.

These moves will allow the overnight rate to drop virtually to zero, from 0.15 percent now.

The BOJ said it was letting the market establish interest rates itself.

"It certainly is a return to zero rates," said James Malcolm, senior Japan economist with J.P. Morgan.

Back to last August's experiment

Hopes for an easier monetary policy have been growing in political and business circles. Worries about the future of the Japanese deflation-ridden economy have sent stock markets in Tokyo and New York plunging.

When the Bank of Japan last August abandoned the zero interest rate policy it began in 1999, it said there were no dangers of deflation.

But last week, the government announced the Japanese economy had entered a state of deflation for the first time since the end of World War II.

The Japanese government has put increasing pressure on the central bank to come to the economy's aid.

Bank officials had previously resisted calls for it to set specific inflation targets or to buy Japanese government bonds.

But Monday the central bank said it would pursue the reserve-targeting policy until the consumer price index, which tracks inflation and has fallen for the past two years, stabilizes above zero.

The BOJ said it would buy Japanese government bonds as needed to implement its target.

The yen strengthened sharply after the announcement. It rose to 122.82 to the U.S. dollar from 123.5 immediately prior to the announcement.

Richards said currency traders appeared to have overanticipated quantitative easing, which would typically weaken the currency.

He said he expected a positive reaction from equity markets when they reopen Tuesday.

The BOJ has traditionally linked such forceful intervention with promises from Japan's government to act on issues such as bank reform.

There was no such announcement this time. But market participants said they hoped the BOJ's action opened the door to tackling the problem of a vast amount of bad loans on Japanese banks' books.

"Coupled with aggressive measures to deal with overhang of bad bank debt, it would be a very powerful one-two punch," Richards said.

The BOJ's unusual move recalled a U.S. precedent from 1979.

In a mirror image of Monday's events, then-U.S. Federal Reserve Chairman Paul Volcker switched from focusing on U.S. interest rates. He instead cut bank reserves in an effort to control inflation.

The U.S. Federal Reserve's Open Market Committee meets Tuesday on U.S. interest rates. Analysts expect a cut of half a percentage point or possibly three-quarters of a point.

Reuters contributed to this report.

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