Bloomberg: Bank of Japan Keeps Rate Unchanged; 3 Members Dissent

By Mayumi Otsuma

Jan. 18 (Bloomberg) -- The Bank of Japan held its benchmark interest rate at 0.25 percent, averting a clash with government officials who say consumer spending and inflation are too weak to withstand higher borrowing costs.

Policy makers kept the overnight lending rate unchanged for a sixth month in a six-to-three decision, the bank said in a statement today in Tokyo. The split vote prompted traders to increase bets the bank may raise rates in February.

The decision may cool government opposition to higher rates before the release of fourth-quarter data next month, which the bank predicts will show a rebound in household spending. Governor Toshihiko Fukui plans to gradually raise rates to prevent a repeat of a stock and property bubble in the 1980s that foreshadowed a decade of stagnation.

``The impression that they caved to political pressure is unavoidable,'' said Noriko Hama, professor of economics at Doshisha Business School in Kyoto. ``It's not a bad decision, given the statistics, but it certainly does not look good for the BOJ.''

Investors increased bets that the bank will raise rates in February to a 67 percent chance, up from 42 percent before the decision, according to Credit Suisse Group. Credit Suisse calculates the chances of a quarter-point rate increase based on trading in contracts for the exchange of interest payments.

The previous six decisions to keep rates on hold were unanimous.

``The split vote means the BOJ will probably raise rates next month,'' said Tetsuhisa Hayashi, chief currency trader in Tokyo at Bank of Tokyo-Mitsubishi UFJ Ltd.

Media Speculation

The yield on five-year notes climbed 3 basis points 1.24 percent at 2:11 p.m. in Tokyo.

Yesterday bonds rose the most in almost four months after Kyodo News, the Nikkei newspaper and NHK Television said the central bank was likely to keep the rate at 0.25 percent.

That caused bets for a rate increase today to drop to a 22 percent chance from 80 percent at the start of the week, when media reports said policy makers were leaning toward an increase.

``It turned into a bit of a fiasco, and puts the Bank of Japan in a very bad light,'' said Hama. ``It's very unfortunate.''

Japan's economy expanded at the slowest pace in almost two years in the third quarter of 2006 as consumer spending dropped 0.9 percent, the biggest decline in almost a decade, masking growth in corporate investment and exports.

Consumer spending, which accounts more than half of the economy, probably ``had a big jump in the fourth quarter,'' Hideo Hayakawa, the central bank's chief economist, said at an economic forum on Jan. 10.

Fourth-Quarter Growth

The government will publish fourth-quarter GDP numbers in the middle of next month, a week before the central bank's next board meeting on Feb. 20-21.

``Consumer spending seems to have recovered considerably in the fourth quarter,'' said Teizo Taya, a former Bank of Japan policy board member who's now an adviser to Daiwa Research Institute. ``The Bank of Japan may want to hold off a rate increase until seeing the GDP numbers, which will probably be convincing.''

Gross domestic product will probably expand an annual 2.9 percent in the fourth quarter, according to a Bloomberg News survey of economists, up from 0.8 percent in the third.

The central bank may also want to examine more inflation data before a rate increase. Core consumer prices, which exclude fresh food, rose 0.2 percent from a year before in November, up from a 0.1 percent gain in October.

The 33 percent drop in crude oil prices may drag the inflation measure lower.

Deflation Risk

``With crude oil prices dropping at a faster than expected pace, core prices turning negative is not just a risk, but a real possibility,'' said Takehiro Sato, chief economist at Morgan Stanley Japan Securities Co. in Tokyo. Some investors ``are dumbfounded as to how a rate hike can be justified when prices may slip into a negative territory.''

In the lead up to today's decision government officials have been voicing concern that an increase this month may be too early.

Economic and Fiscal Policy Minister Hiroko Ota said on Jan. 16 that Japan's consumption remains weak and that there is no guarantee the economy wouldn't slip back into deflation following a rate increase.

Hidenao Nakagawa, secretary general of the ruling Liberal Democratic Party, said on the same day a rate increase can't be justified given the current state of the economy and consumption.

Prime Minister Shinzo Abe's government, focusing on policies to spur growth and stop the expansion of the world's largest public debt, wants to avoid an economic slowdown ahead of elections in April and July.

Abe's View

Abe yesterday said that the government and the central bank shared the goal of beating deflation and achieving strong economic growth and that he believed the central bank would ``make an appropriate judgment.''

The government estimated last week a 1 percentage point increase in short-term interest rates would shave Japan's GDP by 0.4 percentage point. A similar increase in the yield on Japan's benchmark 10-year bond would increase the country's annual debt- servicing costs, which already eat up a quarter of total spending, by about 1.6 trillion yen, the finance ministry estimated in December.

The central bank will publish its monthly economic report at 3 p.m. Fukui will speak at a press conference at 3:30 p.m.

To contact the reporter on this story: Mayumi Otsuma in Tokyo motsuma@bloomberg.net
Last Updated: January 18, 2007 00:11 EST