Business - Bank of Japan cuts rates for first time in 7 years

Martin Fackler

TOKYO: The Japanese central bank cut its benchmark interest rate for the first time in seven years on Friday, joining earlier moves by the Federal Reserve and other central banks to soften the brunt of a possible global recession.

The Bank of Japan's policy board voted to lower the overnight lending rate between banks by 0.2 percentage point to 0.3 percent, reducing borrowing costs in order to rekindle growth in the country, which has the largest economy in Asia. The bank also seemed to confirm fears here that Japan was heading into a recession by lowering its forecasted growth rate for the current year to around zero percent, citing higher energy prices and weakening demand for Japanese exports.

The loosening Friday was also aimed at easing a growing credit crunch in Japan, which had long seemed immune to the international financial contagion. As an additional credit-easing measure, the bank said it would start paying interest on some of the reserves that commercial banks keep at the central bank, a step that would provide more cash to lenders.

This was the first interest rate cut during the current financial crisis by Japan, where short-term interest rates, already near zero, have constrained the central bank's room for maneuver.

Bank officials have said that they feel hard pressed to find ways to coordinate with the Fed, which cut its benchmark rate to 1 percent on Wednesday, and other world central banks in combating the current economic downturn. The European Central Bank, the Bank of England and the Reserve Bank of Australia, which have all already lowered rates in recent weeks, are also widely forecast to deliver another cut next week.

The unorthodox size of the rate cut in Japan, whose central bank usually makes in quarter or half percentage-point steps, seemed to reflect a desire to maintain as much space as possible for additional cuts if needed, economists said. The eight current members of the policy board were split 4-4 on the cut, with the bank governor, Masaaki Shirakawa, casting the deciding vote in favor, the bank said.

Borrowing rates have been stuck at low levels here for more than a decade, as domestic growth in the export-driven Japanese economy never fully recovered from the collapse of its late-1980s real estate and stock market bubbles. The Bank of Japan had until now limited itself to less dramatic moves, like supplying dollars and yen to money markets to ease the global credit crunch.

Economists said that the easing Friday had symbolic value as a sign of Japan's willingness to coordinate with other governments in treating the global economic malaise. But they said the small size of the move would make it unlikely to stimulate much of an increase in actual borrowing.

The Japanese stock market reacted badly to the rate cut - investors had expected a larger cut - sending the Nikkei 225 down 5 percent on Friday. Despite a rally earlier in the week, the index lost a total of 24 percent in October - its worst month on record.

"The bank is making an effort to offset some damage from declining exports," said Richard Jerram, an economist in Tokyo for Macquarie Securities. "But a cut of this size is not really going to change anybody's world."

With low interest rates and a huge fiscal deficit, Japan has few real options for stimulating its $5 trillion economy, the world's second-largest, after the United States. The government has released a series of spending packages, including one Thursday valued at $51 billion that would give income tax rebates to households.

With the United States now apparently heading into recession, Japanese policy makers have looked for ways to pick up some of the slack in global growth. But like many Asian countries, Japan appears highly vulnerable to the U.S. slowdown because of its continued reliance on exports, and relatively weak consumption at home.

Japanese exporters have also been hurt by the yen's sharp rise against other key currencies in the past few months. The rally has made exporters' goods more expensive in markets like the United States and Europe, prompting a string of companies to slash their earnings forecasts. The latest to do so were Nissan and Suzuki, which revised their outlooks on Friday.

Also on Friday, a survey of purchasing managers showed that manufacturing activity had fallen to a near-seven year low in October, evidence of the deteriorating conditions in Japan's manufacturing sector.

The Bank of Japan cited declining demand in the United States in particular in making its forecast of no growth this year, followed by around 0.5 percent growth next year.

Previously, the bank had forecast growth of 1.2 percent this year and 1.5 percent next year.

"Increased sluggishness in economic activity will likely remain until around the middle of fiscal 2009," the forecast said.

With the loosening Friday, the bank appeared to decide that now was the time to send a stronger signal to restore confidence in panic-stricken financial markets. Reports in the Japanese press earlier this week that a rate cut was in the works were enough to spark a rally in Tokyo's beleaguered stock markets.

The stressed state of the Japanese banking sector was apparent Friday, when the country's two largest banks, Mitsubishi UFJ Financial Group and Mizuho Financial Group, cut their earnings outlooks by more than half.

The central bank also decided to lower the so-called Lombard rate, the rate at which the central bank lends to commercial banks, by a quarter percentage point to 0.5 percent.

As the Japanese economy has faltered, there have been increasing complaints by smaller businesses that they are having trouble getting new loans. The decision to pay interest on reserves at the central bank is meant to combat this by effectively stuffing private banks with extra cash, in hopes that they would lend more of it to businesses and consumers. The Bank of Japan took similar steps to end a domestic cash crunch in the late 1990s, when its domestic economy suffered a banking crisis.

According to Jerram, of Macquarie, one lesson of Japan's experience with such indirect measures is that they work only if bankers are confident that they will remain in place until the economy actually revives. To make this clear, he said the bank should accompany such an easing with public commitments not to raise borrowing costs again until some target is met, such as a rebound by consumer prices.

Bettina Wassener contributed reporting from Hong Kong.