FinancialAdvisor's College Class (FACC)

[FinancialAdvisor]

Bank of Japan set to predict yet more deflation

Bank of Japan set to predict yet more deflation
By David Pilling in Tokyo
Published: April 21 2005 09:51 / Last updated: April 21 2005 09:51



The Bank of Japan is poised to abandon its forecast of a return to inflation this fiscal year, delaying an exit from zero interest rates until the year to March 2007 at the earliest, according to Yutaka Yamaguchi, former deputy governor.

Mr Yamaguchi said the BoJ’s much-watched half yearly forecast, due out next week, would reverse its October prediction that the economy would finally climb out of deflation this year by registering a rise of 0.1 per cent in consumer prices. Instead it would predict yet more deflation, he said.

“The actual price development is running below the forecast path… which leads us naturally to think that the forecast would be negative rather than positive,” he said. He expected the BoJ to soften the blow by predicting inflation in the year to March 2007. But a projection so far ahead lacked credibility, he added.

The ending of zero-interest rate policy - and with it the normalisation of Japan’s monetary framework - would now almost certainly be pushed beyond this fiscal year, though even after that “the timing of exit is still highly uncertain.”

The assessment of the former governor, who still carries considerable weight in policy-making circles, will come as a blow to Japanese investors with hopes of an early end to deflation.

Consumer prices have been falling for more than seven years and in February, they were still dropping by 0.4 per cent. The BoJ has blamed some of the fall on deregulated utility prices. The economy has also slowed more sharply than expected - subsequent data have revealed it was in a technical recession when the BoJ made its optimistic projections last October.

Jesper Koll, economist at Merrill Lynch, said the BoJ was likely to downgrade its CPI forecast for the year to minus-0.1. “When the facts change you change your outlook. And the facts have changed,” he said. Since October, economic data had been weak and business confidence had fallen.

Mr Yamaguchi, who oversaw the introduction of the current ultra-loose monetary policy from March 2001, said the so-called quantitative easing framework had failed in its principal aim of stimulating economic and price activity. Under quantitative easing the bank floods the market with excess liquidity.

The aim had been specifically to promote an expansion of banks’ balance sheets, he said, but in fact these had contracted ever since the policy was introduced. “It is evident that the core transmission mechanism of this policy did not function,” he said.

Mr Yamaguchi’s assessment of the purpose of quantitative easing contradicts the present board's official interpretation. The current board says quantitative easing was introduced to stabilise the financial system, which it achieved. Mr Yamaguchi said, by contrast, that the real purpose was to fight deflation.

The distinction is important because the BoJ has been talking openly about the possibility of reducing liquidity targets on the grounds that the banking system has stabilised. Some economists have criticised such a move arguing that it would be seen by markets as a tightening, since it was described as a loosening when it was being phased in.

Mr Yamaguchi said it was indeed time to start normalising monetary policy because the economy had proved itself capable of growing even with mild deflation. Zero interest rates punished savers and rewarded borrowers, he said, a distortion that should be ended as soon as possible.


LINK: http://news.ft.com/cms/s/c32ce34c-b23e-11d9-bcc6-00000e2511c8.html