BOJ to Raise Rates Gradually, as Much as Possible

The Bank of Japan aims to raise borrowing costs ``gradually, and as much as possible'' to regain its ability to influence the economy with monetary policy, Governor Toshihiko Fukui said.

``For the time being, we will maintain an accommodative monetary environment by holding interest rates as low as possible to support economic growth,'' Fukui said in parliament today. ``We'll increase interest rates gradually, and as much as possible, to recover the function of interest rates.''

The Bank of Japan lost its main policy tool in 2001 when its cut interest rates to zero and started pumping money into the banking system in an attempt to stamp out deflation. The bank yesterday doubled its benchmark rate to 0.5 percent, a level that still lags behind the world's major economies.

``We are going to see the bank put more focus on reviving the function of interest rates rather than trends in prices and the economy,'' said Seiji Adachi, a senior economist at Deutsche Securities Inc. in Tokyo. ``Even though interest rates have been rising, they still aren't functioning sufficiently.''

The closest benchmark borrowing costs among major economies to those of Japan are in Switzerland, which has a 2 percent rate. The U.S. Federal Reserve's benchmark rate is 5.25 percent and the European Central Bank has a rate of 3.5 percent.

The yen traded at 121.01 per dollar at 1:06 p.m. in Tokyo, from 120.93 yesterday, when it had the biggest slide since Dec. 8 amid expectations traders will continue to borrow yen to invest in higher yielding currencies. The yield on Japan's benchmark 10-year bond fell 1 basis point to 1.675 percent.

Prices May Fall

``The market perceives that the bank is unlikely to lift rates for a long while after yesterday's rate hike, so the yen is a sell against all currencies,'' said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo.

Fukui has said since at least October 2005 that interest rates need to rise as prices increase and the economy expands after almost 15 years of stagnation following the bursting of the bubble economy of the 1980s.

Fukui said he wasn't concerned about the possibility that core consumer prices may drop in coming months as a result of declines in fuel costs. The price of Dubai crude, a benchmark for Asian refiners, has dropped by a fifth in the past six months.

``There is a possibility that core prices, because of crude oil and other factors, temporarily show a small decline,'' Fukui said. Such a drop ``won't hamper'' the economy's revival, which is fueled by rising output, incomes and spending, he said.

Fukui's remarks appear to signal a monetary policy that is more discretionary, said Okasan's Soma.

``He seems to be saying they'll raise rates even if CPI turns negative,'' said Soma. ``He may be creating an environment in which they can hike rates at their own discretion and provide their own reasons for such moves.''

source:www.bloomberg.com