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Bank of Japan raises key interest rate


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#1 hopoco

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Posted 21 February 2007 - 02:28 AM

Bank of Japan raises key interest rate PrintE-mailDisable live quotesRSSDigg itDel.icio.usBy Chris Oliver, MarketWatch Last Update: 1:48 AM ET Feb 21, 2007 HONG KONG (MarketWatch) -- The Bank of Japan's policy board voted 8- 1 Wednesday to lift its overnight call rate by a quarter percentage point, judging the economy strong enough to handle higher borrowing costs despite weak inflation. In an accompanying statement the BOJ said the economy would continue to grow moderately and that it would adjust rates in the future on a gradual basis depending on the pace of economic growth and prices. "The bank has clearly concluded that the uncertainty on consumption has disappeared," said Glenn Maguire, chief Asia-Pacific economist for Societe Generale in Hong Kong. The overnight call rate will rise to 0.5% from 0.25% currently. The change is the first revision to monetary policy since the BOJ ended it zero-interest-rate policy with a quarter-point rate increase in July. "But where they are more uncertain is on the outlook for prices and they come very close to making a defacto downward revision to their prices outlook," Maguire said, noting the central bank expects changes in consumer prices to remain around zero. The central bank also said weakness in private consumption observed last summer appeared temporary. The statement also said uncertainties relating to the health of overseas economies, including the United States, were abating. Recent economic data, including measures of quarterly gross domestic product growth and consumer consumption, suggested the world's second-largest economy continues on solid footing. However, disappointing wage growth and weak consumer prices point to an economy that some economists said may be too fragile to withstand higher borrowing rates. "The consumer price index and wages have been softening and it remains very difficult for the BOJ to justify a rate hike in a situation where inflation pressure remains quite limited," said Credit Suisse's chief Japan economist, Hiromichi Shirakawa The rate hike was widely expected after Japan's national broadcaster NHK Television reported Wednesday, without citing sources, that BOJ Governor Toshihiko Fukui had proposed lifting the benchmark lending rate. According to Credit Suisse, the market was pricing in a zero percent chance of a 25 basis-point rate hike at the BOJ's next meeting. The estimates were calculated using market-implied interest rate prices. Data released Thursday showed gross domestic product in the October-to-December quarter rose 1.2% from the previous quarter in price-adjusted terms, or 4.8% on an annualized basis, the fastest rate of expansion in nearly three years. The data, which exceeded economists' expectations for a 3.9% annualized gain, were driven by a surge in private consumption from low levels in the previous quarter owing to unseasonable cool summer weather. Private consumption grew 1.1% in the December-ending quarter, reversing a 1.1% decline in the July-to-September quarter. Despite the gains, economists caution the data were inconclusive when viewed in a broader context. "The rise of consumption simply reversed the decline of the previous quarter and spending was up only 0.6% year-on-year, still weakish" said Peter Morgan, chief Asia-Pacific economist for HSBC in an e-mailed report. Japan's core consumer prices rose 0.1% in December from a year earlier, slowing from a 0.2% rise in November, the government said last month. Consumer prices exclude fresh food prices. Morgan said the overall tone of the economic data made it likely he would raise his growth forecast for the Japanese economy in 2007. Morgan did not reveal any revised figures for the upgrade. The fourth-quarter GDP data brought Japan's real economic growth to 2.2% last year, up from 1.9% in 2005. The influential Nikkei newspaper reported Monday that Japan's ruling coalition parties had moderated their opposition to a rate increase in the run-up to the policy board's decision, in contrast to the indirect criticisms leveled prior to the January meeting. The business daily reported the more-distant stance was a nod to the central bank's independence and came amid accusations the government and ruling coalition have been trying to influence monetary policy through political pressure. Despite relatively tame core consumer price inflation, analysts say the BOJ may be shifting its focus towards concerns of rapid asset-price inflation in some areas of the economy that could become a problem if monetary policy remains accommodative. "If the BOJ keeps interest rates too low for too long, something odd will happen in asset prices," said Maasaki Kanno, chief Japan economist for J.P Morgan. J.P Morgan forecasts the economy will expand 2.4% in calendar 2007 and 2.7% for the fiscal year. Kanno said the effects of the BOJ's easy money policy were already reflected in rapidly rising urban property prices, contractions in the yield on Japanese real estate investment trusts, and in the yen's slide against leading currencies. He added asset-price inflation was also fueling some froth in the stock market, although this was less of concern as there were few signs of a generalized bubble in the broader market. "As a risk manager, the BOJ should control the risk that may materialize in the future; this is a lesson that we learned from the 1980s when the BOJ maintained low interest rates for too long to prevent the yen from appreciating, but ended up with asset-price inflation," Kanno said. In its semiannual outlook report revised in January, the BOJ forecast Japan's economy will grow 2.1% in fiscal 2007. Japan has the world's second-largest economy behind the U.S. and one of the world's lowest interest rates. Those low rates have fostered a substantial yield spread with leading currencies. The BOJ benchmark rate of 0.25% has created a yield spread of 500 basis points with the U.S. and the U.K., and 600 basis points with Australia. The BOJ rate is also 345 basis points below the average rate set by the central banks of the Group of Seven leading industrialized nations. Economists say the yield differential is partly responsible for the massive yen carry trade and has helped send the Japanese currency to historical lows against leading currencies on a trade-weighted basis.