Bank of Japan Cuts Rate to 0.3% to Fend Off Prolonged Recession

By Mayumi Otsuma

Oct. 31 (Bloomberg) -- The Bank of Japan cut its benchmark interest rate to 0.3 percent in a split decision to help stave off a prolonged recession.

Governor Masaaki Shirakawa cast the deciding vote to lower the key overnight lending rate from 0.5 percent after four of the eight board members dissented, the central bank said in Tokyo today. Three wanted to cut the rate to 0.25 percent, and one voted to leave it unchanged, Shirakawa said.

Shirakawa, 59, came under pressure to lower borrowing costs for the first time in seven years after the Nikkei 225 Stock Average slumped to the lowest level since 1982 on concern that the global financial rout would deepen Japan's downturn. Until today, the bank had kept rates unchanged in the face of cuts by counterparts worldwide, arguing they were already ``very low.''

``A rate cut will probably do little to prop up the economy; nevertheless the bank was probably fearful they'd be viewed as clinging to an overly rigid stance in the middle of a global crisis'' if they didn't move, said Teizo Taya, a former Bank of Japan board member who now advises the Daiwa Institute of Research.

The yen rose to 96.87 per dollar at 5:54 p.m. in Tokyo, from 98.43 before the decision. Japan's currency climbed as high as 90.93 a week ago, the strongest in 13 years, threatening exporters' earnings. The Nikkei plunged 5 percent today, capping a record 24 percent monthly decline.

The central bank slashed its growth forecast for the year ending March to 0.1 percent from 1.2 percent predicted in July. The economy will expand 0.6 percent next fiscal year and 1.7 percent in the period starting April 2010, it said in a twice- yearly outlook published after the rate decision.

`Severe' Conditions

``All members agreed that economic conditions have become severe,'' Shirakawa said at a press conference after the meeting.

Inflation will evaporate next fiscal year, the bank said. Core consumer prices will rise 1.6 percent in the current fiscal year and fail to increase in the following 12 months, it said. Prices will gain 0.3 percent in the year starting April 2010.

``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 in a statement.

The central bank decided to temporarily pay 0.1 percent interest on reserves commercial lenders hold at the bank to provide liquidity to the financial system. It also trimmed the Lombard rate, or the cost it charges for loans made directly to member banks, to 0.5 percent from 0.75 percent.

Shirakawa said he preferred a key rate of 0.3 percent because it allows equal room between the 0.5 percent Lombard rate and the 0.1 percent interest the bank pays on reserves.

Money Markets

``Shirakawa resisted the call for a larger cut as he believed the efficient functioning of the money markets would be impeded with a larger cut,'' said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong.

Speculation the Bank of Japan would cut rates was fueled by a Nikkei newspaper report on Oct. 29 that said policy makers were leaning toward a reduction. Fifteen of 17 economists surveyed by Bloomberg News predicted a reduction to 0.25 percent.

``Given the state of the economy and financial markets, this is the time to lower borrowing costs,'' said Naoki Iizuka, a senior economist at Mizuho Securities Co. in Tokyo. ``The yen has been weakening because investors already factored in a rate reduction, so it would be difficult for the BOJ to resist.''

The U.S. Federal Reserve cut its benchmark rate to a record- equaling 1 percent this week and China lowered borrowing costs for a third time in two months.

Faltering Economy

Evidence that the world's second-largest economy is faltering mounted in the past month as the global turmoil deepened. Exports climbed 1.5 percent in September, less than half of what economists expected, and factory output tumbled for a third quarter. Reports today showed inflation eased and household spending fell for a seventh month.

``We saw a significant change in conditions in the past month,'' Shirakawa said. ``There was evidence of a clear shift in the real economy in terms of capacity, exports and industrial production.''

Companies are suffering as growth slows. Mizuho Financial Group Inc., Japan's second-biggest bank; All Nippon Airways Co., the largest domestic carrier; Suzuki Motor Corp., Japan's second- largest minicar maker; and Kawasaki Heavy Industries Ltd., the maker of Ninja racing bikes, all cut earnings forecasts today. Daiwa Securities Group Inc., the second-largest brokerage, posted an unexpected loss.

No Indication

Before today, Shirakawa and his board had given no indication they planned to cut borrowing costs, other than to say that policy was ``flexible.'' Even today, policy makers warned that ``from a longer-term perspective,'' keeping borrowing costs low for too long ``may lead to larger swings in economic and financial activity as well as in prices.''

Government ministers welcomed the reduction.

``The Japanese and global economy are in serious shape, so I believe the BOJ made the right decision,'' Finance Minister Shoichi Nakagawa said. Chief Cabinet Secretary Takeo Kawamura said the ``timely'' move was ``probably'' an effort to participate in global cuts.

Cheaper credit may provide some relief to Prime Minister Taro Aso, who yesterday unveiled a $51 billion economic stimulus package in a bid to minimize the effect of tumbling stock prices and the surging yen on the economy.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net