BOJ Keeps Key Rate at 0.3%, Considers Adding Funds

By Mayumi Otsuma

Nov. 21 (Bloomberg) -- The Bank of Japan held its benchmark interest rate at 0.3 percent and said it will consider pumping more money into the financial system to prop up an economy that fell into a recession last quarter.

Governor Masaaki Shirakawa instructed his staff to study new ways of making money available for lending, such as accepting corporate debt as collateral, the central bank said in a statement in Tokyo today. The unanimous rate decision followed a cut from 0.5 percent last month, the first in seven years.

Shirakawa later indicated that he is reluctant to revive the bank's 2001-2006 policy of keeping rates near zero because further reductions could freeze the money market by making it unprofitable for banks to lend to each other. The central bank could be forced to trim borrowing costs anyway should the global financial turmoil prolong Japan's downturn.

``The chance that the Bank of Japan will make a further reduction is slim, given that the governor has underlined the negative effects of zero interest rates,'' said Mari Iwashita, chief market economist at Daiwa Securities SMBC Co. in Tokyo. ``Even so, we can't rule out an additional cut if the economic situation drastically changes.''

The yen traded at 95.04 per dollar as of 5:25 p.m. in Tokyo compared with 94.26 before the announcement. Japan's currency has surged 12 percent against the dollar since September. The Nikkei 225 Stock Average rose 2.7 percent, reversing earlier losses of as much as 3.9 percent. The yield on the 10-year government bond fell 3.5 basis points to 1.4 percent.

`Adverse Effects'

``Given that interest rates are very low, an additional rate cut would have many adverse effects on the functioning of the money market,'' Shirakawa told reporters after the meeting, echoing remarks he made since last month's policy shift.

Rates that are too low will sap interest income to ``a level insufficient to cover various transaction fees, which in turn may reduce the volume of transactions in the market and bring about a reduction in market liquidity,'' he said on Nov. 6.

``Shirakawa is very reluctant to cut rates to zero,'' said Peter Wilson, a strategist at Mitsubishi UFJ Financial Group Inc. in London. ``The Bank of Japan has always stressed the negative side effects of a dysfunctional money-market mechanism.''

The governor also said businesses are struggling to get funding as the global credit crisis deepens.

``Not only small companies but large ones are also having difficulty raising funds from the market,'' Shirakawa said, adding that businesses with low credit ratings are having to pay higher yields in the commercial-paper market.

Hoarding Cash

Banks are hoarding cash on concern the global recession will cripple companies' capacity to repay debt. The balance of commercial paper, which companies use for short-term funding, fell to 12.8 trillion yen ($135 billion) last month, the lowest since March 2002.

Shirakawa told the central bank to ``swiftly'' look at ``possible changes in the treatment of corporate debt as collateral, as well as possible ways to enhance flexibility in funds-supplying operations collateralized by corporate debt,'' today's statement said.

A ``truly awful'' quarterly Tankan business survey in December will be the catalyst for the central bank to start accepting a broader range of collateral, said Glenn Maguire, chief economist at Societe Generale SA in Hong Kong.

Shirakawa acknowledged that banks' fund-raising costs had risen even after last month's rate cut. ``It's true that the effect of the latest rates cuts hasn't sufficiently spread through,'' because investors are concerned about the financial health of Japan's commercial banks, he said.

Tibor Rate

The Tokyo three-month interbank offered rate rose to 0.839 percent today, posting its biggest weekly advance since February 2007. It's 539 basis points higher than the key rate, compared with a 389 basis-point spread before the Oct. 31 reduction.

Some investors and economists say a deteriorating economy will leave the central bank no choice but to cut rates in coming months. There is a 28 percent chance of a reduction by March, according to calculations made by JPMorgan Chase & Co. based on interest-rate swaps trading. Nine of 28 economists surveyed forecast a move by then.

Japan's economy will shrink this year and next in the first back-to-back contractions in a decade, according to economists surveyed by Bloomberg News. Finance Minister Shoichi Nakagawa said today that the government is considering how to counter the stock-market slump that wiped a third of the Nikkei's value since the credit crisis intensified two months ago.

The U.S. Federal Reserve and the European Central Bank will probably cut rates next month after their economies slipped into recessions. Japan will follow ``in the upcoming months,'' said Jan Lambregts.

``We think the global synchronized recession and global financial crisis are serious enough to prompt yet another token cut'' by the Bank of Japan, said Lambregts, head of Asia research at Rabobank International in Hong Kong. ``But we doubt the BOJ is willing to cut rates all the way to zero percent.''

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