BOJ May Trim Rates, Former Deputy Governor Muto Says

By Mayumi Otsuma and Mariko Yasu

Dec. 15 (Bloomberg) -- The Bank of Japan may cut the benchmark interest rate further to show its commitment to countering a deepening recession and market turmoil, said Toshiro Muto, a former central bank deputy governor.

“A central bank has a role of influencing financial market sentiment and a rate cut is an option to show their determination” to support the economy, Muto, 65, said in an interview on Dec. 11. Still, “with the interest rate already so low, a further reduction would have only a limited impact.”

The central bank's Tankan survey today showed confidence among large manufacturers fell the most in 34 years as a deepening global financial crisis crimped export demand, forcing companies to pare production and fire workers. The Bank of Japan trimmed the key overnight lending rate to 0.3 percent from 0.5 percent in October, its first cut in seven years.

Muto served as the central bank's deputy chief for five years through March following his 37-year career at the Ministry of Finance. He was the government's first choice for the central bank chief, only to be rejected by the opposition-controlled upper house, which said his stint at the Finance Ministry may hamper the bank's independence.

Muto, who is now head of Daiwa Research Institute, said that lowering borrowing costs too much could damage the function of financial markets, echoing the views of Governor Masaaki Shirakawa. Since the October rate cut, Shirakawa has said at least eight times that further reductions may impede the flow of funds in the money market by diminishing returns and discouraging trading.

'Snuffed Out'

“As long as interest rates stay even slightly positive, the market mechanism can survive, but that functionality could get snuffed out” if rates are cut to zero, said Muto. “We've learned that that the significance of that from our zero-rate policy.”

Muto said should the turmoil intensify, the bank may revive quantitative easing, a policy of providing more funds to the banking system while holding the key rate close to zero. The bank adopted measure for five years through March 2006.

For now, policy makers should focus on measures to provide sufficient liquidity to lenders to avert a credit crunch, Muto said. Buying commercial paper directly from companies could cause “side effects,” he said. He added the bank doesn't need to increase its monthly purchase of government bonds from lenders from the current 1.2 trillion yen ($13.3 billion).

'Fully Possible'

It's “fully possible” that Japan may intervene in the currency market should it determine the yen's “overshooting” is a threat to the economy, Muto said. Investors are now buying the yen as a “safe-haven asset” because of the relatively better shape of the Japanese economy, he said.

Japan's currency surged to a 13-year high against the dollar last week.

“However, it's hardly conceivable that Japan's economy will improve independently from the rest of the world, and it's fully possible that the yen will weaken should financial market turmoil subsides,” Muto said.

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