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BOJ guides interest rates to near zero

Central bank governor Masaru Hayami
Central bank governor Masaru Hayami  

TOKYO, Japan -- Amid growing alarm about the state of its economy, Japan's central bank has decided to guide down interest rates to near zero.

The Bank of Japan (BOJ) said at a Monday meeting it will inject more money into the economy by raising bank reserves by 1 trillion yen. That effectively pushes interest rates back to zero in an attempt to revive economic growth.

The measures include targeting an increase in commercial banks' reserves.

"That's an extremely aggressive and strong move," said John Richards, Japan strategist with Barclays Capital in Tokyo.

The BOJ's move injects a large amount of money into the Japanese economy -- known as quantitative easing.

IN-DEPTH
 

The BOJ also said it would keep that strategy until deflation stopped. Business interests had called for both quantitative easing and inflation targeting.

Instead of targeting the overnight interest rate, the BOJ said it would pump up the money supply by increasing its overnight reserves to 5 trillion yen from 4 trillion yen.

These moves would allow the overnight rate to drop virtually to zero, from 0.15 percent now.

The BOJ said it was letting the market set the rate itself.

"It certainly is a return to zero rates," said James Malcolm, senior Japan economist with J.P. Morgan.

Hopes for an easier monetary policy had been growing in political and business circles, as worries about the future of the Japanese deflation-ridden economy have sent stock markets in Tokyo and New York plunging.

When the Bank of Japan decided last summer to end the near-zero interest rate policy that it began in 1999, it had said there were no dangers of deflation.

But last Friday, the government announced the Japanese economy had entered a state of deflation for the first time since the end of World War II.

The Japanese government has put increasing pressure on the central bank to come to the economy's aid.

Bank officials had previously resisted calls for it to set specific inflation targets or to buy Japanese government bonds.

But Monday the central bank said it would pursue the reserve-targeting policy until the consumer price index, which tracks inflation and has fallen for the past two years, stabilizes above zero.

The BOJ said it would buy government bonds as needed to implement its target.

The yen strengthened sharply after the announcement. It rose to 122.82 to the U.S. dollar from 123.5 immediately prior to the announcement.

Richards said currency traders appeared to have overanticipated quantitative easing, which would typically weaken the currency.

He said he expected a positive reaction from equity markets when they reopen Tuesday.

The BOJ has traditionally linked such forceful intervention with promises from Japan's government to act on issues such as bank reform.

There was no such announcement this time. But market participants said they hoped the BOJ's action opened the door to tackling the problem of a vast amount of bad loans on Japanese banks' books.

"Coupled with aggressive measures to deal with overhang of bad bank debt, it would be a very powerful one-two punch," Richards said.

Reuters contributed to this report.



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