Japan cuts interest rate

The discount rate is cut for the first time in six years

The Bank of Japan has decided to cut its largely symbolic discount interest rate to 0.35% from 0.5%.

However, Japan's key interest rate, called the overnight call rate, has been kept at 0.25%.

The Bank of Japan (BoJ), led by governor Masaru Hayami, has not cut the discount rate since September 1995.

The move to reduce the discount rate has been interpreted by some economists as an attempt by the central bank, which is independent, to increase pressure on the government to tackle the country's economic problems.

Japanese interest rates

Symbolic discount rate falls to 0.35%

Key overnight rate remains at 0.25%

In the past Mr Hayami has said that the government should take responsibility for kick-starting the economy through structural reform.

Financial markets also see the cut as a sign that the bank is prepared to ease monetary policy further if the economy continues to deteriorate.

Robin Bew, chief economist at the Economist Intelligence Unit, says the rate cut will have "almost no macro impact on the economy" because the size of the cut is relatively insignificant.

"The BoJ is acknowledging that the economy is weak, but is unwilling to cut the overnight rate and so ease pressure for reform on the banking sector," he added.

Masaru Hayami believes the onus is on the government to reform the economy

The discount rate is the rate at which commercial banks borrow from the central bank.

It is rarely used and is not as important as the overnight call rate, which governs the rate at which commercial banks lend to each other.

The BoJ also announced on Friday that it plans to increase the ease with which commercial banks can borrow on the discount rate.

But with the discount rate 0.1% higher than the interbank rate, it is unlikely that many banks would make use of it.

Fears of a recession

The interest-rate cut comes days after the Japanese government revised down figures for the country's gross domestic product, which now show that the economy shrank by 0.6% for July to September.

The government had previously released a preliminary estimate of a 0.2% growth rate.

The Bank of Japan is unwilling to ease pressure for reform on the banking sector

Robin Bew
EIU

The revised figures have revived fears that Japan's depressed economy may even fall into recession, if it contracts in the next quarter as well.

In August, the BoJ made the controversial move of increasing the overnight call rate to 0.25%.

Previously, the BoJ had kept the interest rate close to zero to stimulate growth in the economy.

Mr Bew believes the BoJ wishes keep the key rate at 0.25% to maintain pressure on private-sector banks to sort out bad loans on their books.

While the overnight call rate was closer to 0%, the banks were able to cover their bad loans at very little cost.

Publicly, the BoJ has resisted calls to lower the overnight rate, arguing that deflationary pressures in the economy reflect technological change rather than weak demand.

Annual growth forecasts

The Economist Intelligence Unit forecasts that the Japanese economy will only grow at 0.4% in 2001, compared to its estimate of 1.6% for 2000.

Mr Bew says these figures may even be revised downwards in light of the recent economic figures.

Consumer spending in Japan remains subdued

A recent report by a UK think tank, the National Institute for Economic and Social Research (NIESR), also predicts that the Japanese recovery will be slow.

"The economy will be hit by a sharp decline in the contribution of net exports to growth as world trade slows down," stated the report.

The NIESR also said that domestic demand will not "pick up the baton" because business confidence has stalled and consumer spending remains subdued.

After the interest rate announcement, the euro recovered from five-week lows to rise above 107.4 yen, while the dollar strengthened to highs above 117 yen.