BOJ May Have to Cut Rate as Investors See `Done Deal'

By Mayumi Otsuma

Oct. 30 (Bloomberg) -- The Bank of Japan may have little choice but to cut interest rates tomorrow after a newspaper report raised investors' expectations that it would.

The yen slumped the most since 1974 and stocks rallied after the Nikkei newspaper yesterday said policy makers are leaning toward lowering rates. The central bank came under pressure to move after Japan's currency surged to a 13-year high last week, driving stocks to the lowest level since 1982.

Forgoing a reduction in the benchmark rate from 0.5 percent tomorrow may prompt a rebound in the yen by making the currency more attractive compared with those of countries that are cutting borrowing costs. It could also trigger a resumption of the stock-market slide, economists said.

``If the Bank of Japan fails to take action, global financial markets will gyrate because investors already take it as practically a done deal,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``There is little option for the bank not to act.''

Yoshihiro Sugimoto, chief press officer at the Bank of Japan, declined to comment on the Nikkei report.

The chance that the central bank will trim the key rate to 0.25 percent on Oct. 31 rose as high as 71 percent yesterday from 8 percent before the article was published, according to calculations by JPMorgan Chase & Co. using overnight interest- rate swaps. Expectations finished the day at 50 percent.

Stocks Rally

The Nikkei 225 Stock Average climbed 7.7 percent yesterday and the yen weakened to around 97 per dollar, less than a week after surging to 90.93, the highest since 1995. The Nikkei has still lost a quarter of its value this month as the yen's 9.5 percent gain against the dollar and 21 percent increase versus the euro threatens exporters' earnings.

``The bank now has to deliver to avoid disappointing the markets,'' said Julian Jessop, chief international economist at Capital Economics Ltd. in London. ``We think that rates will be cut all the way to zero again in the coming months.''

Last week, Jessop was among the 30 economists surveyed by Bloomberg News who predicted rates would stay on hold this month. Only two projected a cut.

A reduction in borrowing costs may help to stem the yen's gains by narrowing the interest-rate gap between Japan and other countries. The U.S. Federal Reserve cut its benchmark rate to 1 percent from 1.5 percent yesterday. European Central Bank Governor Jean-Claude Trichet said Oct. 27 he may reduce interest rates next week.

Opted Out

A rate cut would come less than a month after the Bank of Japan opted out of joint reductions made by counterparts in Europe and North America, saying the country's borrowing costs are already ``very low.'' Japan's financial system has until recently avoided the worst of the credit crunch that brought down banks in the U.S. and Europe.

``The situation has changed substantially since then,'' said Tetsufumi Yamakawa, a former central bank official and now chief Japan economist at Goldman Sachs Group Inc. in London. ``At the very least, the BOJ is rapidly losing the option of not doing anything.''

The drop in shares is depleting the capital of Japanese banks, which traditionally hold large stakes in other companies. Japan's six biggest banking groups had an aggregate 1.1 trillion yen ($11 billion) in unrealized losses on their shareholdings as of Oct. 24, according to Daiwa Institute of Research.

Japan's government is struggling to halt the yen's advance and later today will unveil measures to prop up the economy and stock market. Economic and Fiscal Policy Minister Kaoru Yosano said this week that a rate cut would have a ``symbolic'' effect if done in conjunction with other central banks, showing Japan is taking part in global efforts to counter the financial crisis.

Government's Wishes

``The government is the one who wants the Bank of Japan to cut rates this week to show Japan is coordinating with other nations to ease turmoil in markets,'' Mari Iwashita, chief market economist at Daiwa Securities SMBC Co. in Tokyo. Still, ``the economy and markets could worsen further even after they reduce interest rates and that's what the central bank has to think about at the meeting this week.''

Cutting rates would represent a sudden shift for Bank of Japan Governor Masaaki Shirakawa, who has given no indication of a reduction other than to say the board's policy is ``flexible.'' Concerned about future asset bubbles, as recently as Oct. 7 he said prolonging a low-rate policy may overstimulate the economy and make growth unsustainable in the long run.

A reduction would be the first since March 2001, when the bank lowered the benchmark close to zero percent to counter deflation and lift Japan out of a recession.

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