-- Bank of Japan Governor Toshihiko Fukui may say no to an interest-rate increase this week. It won't be his last word on the subject.
Even before the market turmoil of last week, capped off by the U.S. Federal Reserve's surprise Aug. 17 move to lower the interest rate it charges banks, investors were betting BOJ policy makers would forgo an increase at their Aug. 22-23 meeting.
Still, the 71-year-old Fukui, now in the final months of his term, remains determined to secure his legacy of ``normalizing'' monetary policy by raising the lowest borrowing costs in the industrialized world.
``If Fukui can't raise rates from 0.5 percent by March, he would probably feel that he didn't do what he set out to do,'' says Masaaki Kanno, a former central-bank official who is now chief economist at JPMorgan Securities Japan Co.
Resuming rate increases in the world's second-largest economy would put Fukui at odds with the International Monetary Fund as well as with the government of Prime Minister Shinzo Abe. They cite Japan's renewed struggle with deflation -- including five months of falling prices -- as reason to keep the bank's target rate on hold.
In addition, Abe's ruling Liberal Democratic Party, which was routed in upper-house parliamentary elections last month, is eager to avoid any moves that would further roil voters and weaken its already tenuous grip on power. The party's secretary general, Hidenao Nakagawa, told Fukui in an Aug. 7 meeting that higher interest rates hurt regional economies and contributed to the party's defeat, according to Economic and Fiscal Policy Minister Hiroko Ota.
Greater Concern
Of greater concern to Fukui, whose five-year term ends in March, is the danger that leaving borrowing costs abnormally low will fuel risky investments leading to asset bubbles, while depriving his successor of maneuvering room in case Japan's economy stalls.
The same global market turmoil that has taken an August increase off the table -- Credit Suisse Group calculations based on interest payments showed an 8 percent probability today -- reinforces Fukui's point that Japan's abnormally low rates encourage unsafe investment.
``He is concerned that, if they stay so low for long, there will be the risk of resource misallocation,'' Kanno says.
The credit crunch that triggered a global sell-off of stocks this month also drove the yen to its highest level in more than a year as the market turmoil prompted investors to sell risky investments funded by so-called carry trades -- investments funded by low-interest loans in Japan.
Market Gyrations
As markets gyrated, major central banks, including Japan's, injected billions of dollars into the banking system and led to the Fed's surprise discount-rate cut Friday. The yen fell on speculation that the Fed's action might encourage investors to resume carry trades.
Japan's currency traded at 114.51 per dollar at 10:37 a.m. in Tokyo from 114.36 late Aug. 17 in New York.
In an e-mail after the Fed's action, Paul Sheard, global chief economist at Lehman Brothers Holdings Inc. in New York, said that ``there's no need for the BOJ to rush with the next rate hike.'' He added that, ``given the deterioration in financial market conditions and likely Fed response, it makes sense for the BOJ to hold off.''
Still, Sheard said, Fukui may raise borrowing costs in November.
Some Leeway
While bringing Japan's target rate closer to 1 percent would still leave borrowing costs among the world's lowest, it would allow Fukui to leave his successor some leeway to loosen credit if necessary. That's a luxury he didn't have when he took office in 2003.
Under his predecessor, Masaru Hayami, the bank pushed the key rate to near zero in 2001 as global growth faltered. Japan fell into a recession. Consumer prices, which had been dropping since 1999, declined for three more years.
``With zero interest rates, a central bank is equipped with only very limited policy tools,'' says Takuji Aida, chief economist at Barclays Capital in Tokyo. ``A central bank must recover normal interest rates to be able to respond to the economy in a flexible manner.''
A rate increase would be the third since Fukui embarked in July 2006 on a strategy of ``gradually'' raising borrowing costs. He has argued that the bank has room to raise rates now, given sustained growth and the outlook for rising prices.
Structural Recovery
``Japan has entered a meaningful structural recovery,'' says Jan Lambregts, head of Asia research at Rabobank International in Hong Kong. ``Fukui may very well achieve a positive place in history as the BOJ governor who successfully oversaw a cautious return to an interest-rate-driven monetary policy.''
The latest economic data don't make that effort any easier. The Cabinet Office this month forecast that the broadest measure of Japanese consumer prices will be unchanged in the year ending March 31, 2008, down from its January projection of a 0.2 percent increase. Ota says the figures mean that the end of Japan's deflation ``has been delayed.''
Japan's growth slowed in the second quarter more than economists had predicted, falling to a 0.5 percent annualized rate from 3.2 percent in the first quarter.
The IMF further complicated Fukui's task this month when it said the central bank needn't rush to tighten credit because inflation isn't a threat and Japan's borrowing costs are at ``appropriate'' levels.
Taking Sides?
``The IMF seems to be siding with the Japanese government over the BOJ,'' says Marc Chandler, New York-based global head of currency strategy at Brown Brothers Harriman & Co.
Last month's elections, when the opposition Democratic Party of Japan trounced Abe's Liberal Democratic Party, may increase the chances that Fukui's successor will break with his policies. The DPJ opposes Deputy Governor Toshiro Muto, 64, who was the favorite to succeed him prior to the election, according to a Bloomberg survey of 15 economists in June. Muto has supported Fukui's stance of gradually tightening credit.
Now Kazuo Ueda, 55, a University of Tokyo professor and former policy maker who dissented when the bank raised its key rate in August 2000, has emerged as a possible alternative candidate. Ueda would probably seek to ``avoid hampering overall growth with a rate hike,'' whereas Muto could be expected to ``follow Fukui's basic stance of raising interest rates gradually,'' says Hiroshi Shiraishi, an economist at Lehman Brothers in Tokyo.
Two More
Whoever the successor is, economists predict that Fukui will have squeezed in two more rate increases before he's sworn in. Thirteen out of 18 surveyed by Bloomberg News forecast that the key overnight lending rate will be at 1 percent by March. Among those cheering him on is Reserve Bank of Australia Governor Glenn Stevens, who said in his semiannual testimony to his country's parliament Aug. 17 that ``the sooner the Japanese interest rates are able to be normal again, the better from the point of view of the global financial system.''
The word ``normal'' and variations on it occur over and over in discussions of the BOJ governor's goal.
``Fukui still wants to show that Japan needs to normalize rates,'' says Naomi Fink, senior currency strategist at BNP Paribas in New York. ``There's a risk to credibility if they don't show the courage of their convictions. Pulling back from raising rates is saying that the volatility we've seen is going to get worse. No central bank wants to be the first one to say that.''
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