Bank of Japan May Resist Pressure to Escalate Deflation Fight

Feb. 18 (Bloomberg) -- The Bank of Japan will probably refrain from expanding its lending and asset-purchase programs today, preserving policy ammunition in case deflation deepens and the government increases pressure for more action.

Governor Masaaki Shirakawa and his colleagues will keep the loan facility for commercial banks and monthly purchases of government bonds unchanged, 14 of 16 economists surveyed by Bloomberg said. All of the analysts said the bank will maintain the benchmark interest rate unchanged at 0.1 percent.

A report this week showed a broad measure of prices fell the most in more than half a century even as economic growth accelerated last quarter. As concerns about public debt mount worldwide, Prime Minister Yukio Hatoyama’s government may find little room to maneuver fiscal spending and instead put more heat on the BOJ to prop up the economy ahead of a July election.

“We must be careful about the risk that investors will shift their focus to Japan’s public debt in coming months as their next target after Europe,” said Mari Iwashita, chief market economist at Nikko Cordial Securities Inc. in Tokyo. The government “will have no other choice but to depend on the BOJ if the yen suddenly strengthens and markets become volatile.”

The announcement is expected early afternoon in Tokyo, and Shirakawa will brief the press at 3:30 p.m.

Signs of political pressure are already surfacing. Finance Minister Naoto Kan said this week in parliament Japan should adopt a “policy target” of achieving 1 percent inflation and the government wants to work with the bank to spur prices.

Not Alone

Speaking at the same committee, Shirakawa said deflation can’t be beaten by the central bank alone, while adding that it will act “decisively” should financial markets become volatile. BOJ board members have stopped short of adopting inflation targeting, saying in December that their “understanding” of price stability is increases of up to 2 percent, with a median of 1 percent.

“Given the recent circumstances, we should assume calls on the BOJ to take action will definitely mount,” said Teizo Taya, a central bank board member for five years to 2004. “The bank’s next move is probably to expand the existing programs and inject more funds” into the banking system, said Taya, who is now an adviser at Daiwa Institute of Research in Tokyo.

The central bank introduced the 10 trillion yen ($111 billion) lending facility for commercial banks in December after the yen surged to a 14-year high of 84.83 against the dollar and Cabinet ministers including Kan urged it to do more to fight deflation. Two of the surveyed economists say the bank may raise the lending limit beyond 10 trillion yen today.

Weaker Yen

The Japanese currency has weakened more than 3 percent and the Nikkei 225 Stock Average has gained 7.7 percent since the Dec. 1 move.

Gross domestic product grew at an annual 4.6 percent pace in the three months ended Dec. 31, fueled by rising exports that prompted manufacturers from Panasonic Corp. to Nissan Motor Co. to raise their profit forecasts. Even so, the GDP deflator tumbled 3 percent, the biggest drop since records began in 1955, and the domestic demand deflator, a gauge that excludes imports, slid 2.9 percent.

“It’s highly probable that growth will decelerate temporarily” as the effect of fiscal stimulus wanes, said Tetsufumi Yamakawa, a former BOJ official and now chief Japan economist at Goldman Sachs Group Inc. “Even if the central bank stands pat this month, it will likely be compelled to ease monetary policy further by summer.”

Loan Program

The bank may consider extending the period of the loans to six months or a year from the current three months, Yamakawa said. Increasing the bank’s monthly government bond purchases from 1.8 trillion yen is another option, he said.

Shirakawa may be reluctant to increase sovereign debt purchases because that might encourage the government to issue more bonds, said Ryutaro Kono, chief economist at BNP Paribas.

“Given that the government has yet to compile a long-term fiscal rehabilitation plan, more bond buying may lead investors to conclude that the BOJ will monetize the debt,” Tokyo-based Kono said. “That’s a considerably tricky policy.”

Standard & Poor’s last month warned that it may cut Japan’s AA credit rating unless the country develops a plan to contain the debt, which is already the world’s largest and approaching 200 percent of GDP.

Credit-default swaps tied to Japan’s government bonds showed an increase in risk. The cost of protecting the debt from default for five years has doubled to 81.9 basis points since the Hatoyama administration started on Sept. 16, according to prices from CMA DataVision in New York.

Bank of Japan policy makers have started to call on the government to contain fiscal expansion. Board member Seiji Nakamura said on Feb. 4 that concerns about public debt in Europe shouldn’t be regarded as “a burning house on the other side of the river.”