Japanese interest rates cut for first time in seven years

publication date: Oct 31, 2008

The Bank of Japan today cut interest rates for the first time in seven years, in its first demonstration of support for rate-cutting measures taken by other central banks in response to the global financial crisis. In a move some criticized as half-hearted, the bank cut the key interest rate from 0.5% to 0.3% at the end of a meeting that revealed deep divisions among the nine members of the bank's policy board.

The central bank had come under mounting pressure to overcome its reluctance to reduce the rate - already the lowest in the industrialised world - in an attempt to rein in the surging yen and prop up the ailing stockmarket. Many economists had predicted rates would be halved to 0.25% and early signs were that the BoJ's decision, which came a day after the government unveiled a $51bn (£31bn) stimulus package, would have little impact. In Tokyo the Nikkei 225 index sank 5% to 8576 and the yen strengthened further against the dollar, edging up to ¥97.77 shortly after the BoJ announcement. Analysts said the lower-than-expected cut and divisions among the BoJ board risked sending out the wrong signals about Japan's commitment to coordinated measures to drag the global economy out of the quagmire.

"The market had hoped for a 25 basis-point rate cut by a majority vote, without taking such a long time," said Yuji Saito at Societe Generale in Tokyo. "Today's decision may give an impression to foreign investors that the Bank of Japan will not be able to manage rate decision flexibly. "From foreign investors' viewpoint, it may also give the impression that the BoJ is not cooperating with central banks in major economic zones." The BoJ board was split straight down the middle, with four votes in favour and four against. The bank's governor, Masaaki Shirakawa, was forced to step in when it became clear that four members of the board, all with private sector backgrounds, refused to budge.

Shirakawa, who just a fortnight ago insisted no action was necessary, appeared to have little choice but to support a cut in borrowing costs at the end of a month in which the Nikkei plummeted to its lowest level for 26 years and the yen surged to a record high against the dollar.

The strong yen has eaten into the profits of Japan's exporters, with Sony, Toyota and Fujitsu all reporting miserable profits for the second quarter this week. After they appeared to have been spared the misery affecting their counterparts in the US and Europe, Japanese banks have seen their capital eroded by record falls the Nikkei. Today, Mizuho financial group, Japan's second biggest bank, said it had lowered its profit forecast for the current fiscal year by more than half because of the fall in its share price.

The bank, Japan's second biggest by revenue, said it now expects full-year net profit to reach ¥29bn (£181bn), down 55% from its previous forecast of ¥560bn. The BoJ said a rate cut was necessary to maintain flexibility in the money markets amid signs that Japan's economy is slowing down. "Adjustments in the world economy stemming from financial crises in the United States and Europe have further increased in severity," it said in a statement. "Under these circumstances, increased sluggishness in Japan's economic activity will likely remain over the next several quarters with exports leveling off and the effects of earlier increases in energy and materials prices persisting." The bank said it had concluded that, "a reduction in policy interest rates and a further increase in the flexibility of money market operations were necessary to maintain accommodative financial conditions." Today's cut is the first since Japan introduced a near-zero rate in March 2001, marking the start of its quantitative easing policy, or flooding the market with cash. The policy ended in July 2006 with a modest increase of 0.25%, followed by another 0.25% rise in February last year. The rate cut comes two days after the US Federal Reserve cut rates by 0.5 percentage points to 1%. Next week, the Bank of England is expected to cut at least half a percentage point off its benchmark rate of 4.5% on Thursday. The European Central Bank is thought to be considering a cut of 0.5 points the same day to take its key rate to 3.25 %.