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Keeping rates too low may spur risky investing: BOJ

(Japan) Although bank keeps rates unchanged, governor’s words signal he intends to raise borrowing costs TOKYO – BANK of Japan (BOJ) governor Toshihiko Fukui said there is a risk that keeping interest rates too low will spur risky investment, signalling that the central bank intends to raise borrowing costs.

‘Distortions and the misallocation of resources could occur if interest rates are kept at levels inconsistent with the economy,’ he told reporters in Tokyo yesterday, after his board kept interest rates on hold as expected.

‘Our policy is forward-looking and we can act when we’re confident in our judgment.’

Central banks in Japan, the United States and Europe injected more than US$350 billion (S$535 billion) into the banking system this month, after credit dried up following the collapse of the US sub-prime mortgage market.

Mr Fukui’s comments indicate that he may resume his policy of gradually increasing borrowing costs later this year.

Mr Richard Jerram, chief Japan economist at Macquarie Securities in Tokyo, said: ‘If stability returns in the coming weeks, then the BOJ will probably feel comfortable to raise rates in a month.’

Investors see a 39 per cent chance of a rate increase next month, according to Credit Suisse Group calculations based on interest payments.

Mr Fukui said the central bank’s policy needs to dissuade investors from making one-sided bets in the currency market. Still, he maintained that monetary policy is based on an analysis of the economy and prices.

‘It’s highly likely that the Japanese economy will achieve sustainable growth with stable prices,’ he said, repeating last month’s assessment.

‘However, we’ll examine upcoming data and financial market movements at home and abroad and will make an appropriate policy judgment.’

Japan’s key rate of 0.5 per cent is the lowest among major economies.

Mr Fukui has said the bank needs to normalise policy now that the economy has overcome 15 years of stagnation that followed the bursting of a stock and property bubble in the early 1990s.

He described the tumult as a ‘repricing’ process and said investors are adjusting from a ‘too-loose’ judgment of risk. He said the bank will watch whether the correction is orderly and whether the moves will affect economic growth.

‘It’s not the type of problem that will go away in a few weeks,’ he said.

Some analysts said the US Federal Reserve’s decision last Friday to cut the rate at which it lends to banks may have made it difficult for the BOJ to tighten credit.

Mr Fukui said the BOJ is not influenced by the policy judgment of other central banks. Each monetary authority views the prospects for growth and prices in its own economy, he said.

‘Although Fukui denied the BOJ’s policy should be simply affected by other central banks, it’s not realistic to expect a BOJ rate hike when the Fed’s cutting rates,’ said Bank of America senior economist and strategist Tomoko Fujii.

The BOJ’s next decision will be on Sept 19, a day after the Fed holds its regular policy-setting meeting.

Interest-rate futures show traders are betting the Fed will cut its key overnight lending rate on Sept 18 or earlier.

The European Central Bank this week added more funds to the banking system, while saying it would stay vigilant on inflation, prompting investors to raise bets of a Sept 6 rate increase.

Source: BLOOMBERG NEWS (The Straits Times 24 Aug 07)

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