THE BANK of Japan this week pledged to pump more funds into the struggling economy and keep rates virtually at zero, surprising markets and stealing a march on the US Federal Reserve in providing a dose of economic stimulus.
The yen initially fell, but later reversed course to be firmer against the dollar.
For months, the central bank had rejected government calls for more decisive action, such as buying more government bonds, focusing instead on a limited funding scheme.
But in the face of growing evidence that the yen's strength was hurting the economy, it carried out what governor Masaaki Shirakawa described as "comprehensive monetary easing".
It cut its overnight rate target to between zero and 0,1 percent, from 0,1 percent, reinstating the "zero-interest" policy that ended only in July 2006, and pledged to buy ´5-trillion (60 bn) worth of assets.
It said it would keep its benchmark rate effectively at zero until price stability is in sight, adopting a US Federal Reserve-style commitment to ultra-loose policy. Core consumer prices have been falling from year-earlier levels since early last year and the country has been in and out of deflation for about 15 years.
"The latest measures individually may be considered as not having a major effect, but we want to maximise the effect by implementing the steps as a package," Shirakawa said, adding that there were elements both of credit easing and an expansion of fund supply.
The asset purchases would roughly match the size of extra stimulus being mulled by the government, which is running out of policy options in the face of public debt twice the size of the 5-trillion economy.
The assets, ranging from government bonds and short- term government securities to commercial paper and corporate bonds, would come under a temporary scheme that would also cover ´30-trillion of such assets as collateral under an existing loan programme.
But analysts were sceptical. "The initial reaction was positive, but it's not clear how they're going to prevent deflation from intensifying ," said Tim Condon, chief economist at ING Financial Markets in Singapore. The scepticism was reflected in markets.
After initially weakening to almost 84, the yen rebounded to 83,40 before midday. The Japanese government bond yield curve steepened, with most yields falling, but 30-year yields rose on disappointment the measures were not more aggressive. The Nikkei stock average rose 1,5 percent though, its biggest gain in almost three weeks, in the hour-and-a-half of trading that remained after the Bank announcement.
Bank policy makers have signalled in past weeks they were considering easing policy further, after Tokyo's intervention last month to check yen strength offered only temporary relief.
Most market players, however, had expected the bank to opt for a relatively minor adjustment of its ´30-trillion loan scheme that supplies banks with funds at 0,1 percent rate.
This week's decision drives the bank closer to full quantitative easing it conducted between 2001 and 2006, under which it flooded market systems with excess cash and left markets to set the overnight call rate. But this week it said it would keep paying 0,1 percent interest on excess reserves held with it, providing a floor for market rates and suggesting it would only temporarily allow rates to fall below 0,1 percent.
Growth slipped from a healthy annualised rate of 5,0 percent in the first quarter to 1,5 percent in the second quarter. Data last week showed exports growth slipped for a sixth straight month in August. "Governor Shirakawa used the phrase 'comprehensive easing' instead of 'quantitative easing' .... He liked to differentiate from the previous easing measures," said Susumu Kato, chief economist at Credit Agricole in Tokyo.