Bank of Japan May Cut Benchmark Interest Rate Further
According to a former central bank official, Toshiro Muto, the Bank of Japan may cut the benchmark interest rate further to show its commitment to countering a deepening recession and market turmoil.
The central bank's Tankan survey today showed confidence among large manufacturers declined 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, 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.
“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.”
Should the turmoil intensify, Muto added, 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).