BOJ May Cushion Balance-Sheet Contraction Next Week (Update2)

March 12 (Bloomberg) -- Japan’s central bank may seek next week to counter a contraction of its balance sheet caused by the month-end expiration of an emergency-credit program as deflation persists in the world’s second-largest economy.

The Bank of Japan’s options include expanding a 10 trillion yen ($111 billion) fund providing loans to banks, according to two central bank officials who spoke on condition of anonymity. The March 16-17 policy meeting comes days before the March 31 end of an unlimited collateralized loan facility.

By making some announcement about sustaining the BOJ’s 19 trillion yen balance-sheet expansion, Governor Masaaki Shirakawa may reassure investors and politicians anticipating additional liquidity. The bank may want to save broader measures for April, when officials can discuss coming household and business confidence surveys and updated economic forecasts.

“The BOJ would run a bigger risk if it takes no policy action this time, even though the board members probably hope to preserve easing options as much as possible,” said Hideo Kumano, a former central bank official and now chief economist at Dai- Ichi Life Research Institute in Tokyo. The bank will likely modify the 10 trillion yen program “and try to maintain the level of ample liquidity it has provided up to now,” he said.

The Japanese currency declined against the euro and dollar today on speculation the central bank will take further steps. The yen dropped to 124.13 per euro at 2:29 p.m. in Tokyo after earlier falling to the weakest level since Feb. 23. Against the dollar, the Japanese currency traded at 90.62 from 90.51.

Unlimited Lending

The central bank has lent 9.6 trillion yen under the three- month bank loan program that was introduced in December, close to the current limit. In the unlimited lending facility set to expire this month, there was 5.9 trillion yen outstanding as of Feb. 28. Both facilities offer three-month credit at 0.1 percent.

Japan’s central bankers have overseen an 18 percent expansion of their balance sheet, to 126.8 trillion yen, since before the September 2008 Lehman Brothers Holdings Inc. collapse intensified the credit crisis.

Local media reports last week that said the bank was likely to consider more measures without citing a source for the information have complicated the board’s decision, the officials said. Those reports also stoked investor expectations -- the Nikkei 225 Stock Average has gained 4 percent and the yen has weakened since the reports.

Plugging the hole left by the expiry of the unlimited credit program may help restrain the yen, which at around 90 per dollar hovers above companies’ break-even level of 92.90, weighing on the export-driven recovery.

Insufficient Adjustment

One risk is investors see a balance-sheet adjustment as insufficient, said Naka Matsuzawa, chief investment strategist at Nomura Securities Co. in Tokyo.

“If the BOJ increases the 10 trillion yen program to 15 trillion yen, investors won’t take it as additional easing” because it would barely substitute for the cash under the expiring plan, Matsuzawa said. The bank needs to increase the December program by more or extend the maturity to six months to show it’s injecting more money, he said.

While another option is to increase government bond purchases beyond the current 1.8 trillion yen a month, central bankers have warned at the dangers of appearing to finance the nation’s fiscal deficit.

“Buying more bonds would be a very difficult option for the BOJ unless the government publishes a very convincing fiscal rehabilitation plan and disperses concerns about Japan’s fiscal discipline in markets,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo.

Further Easing

Japan’s focus on the potential for further monetary easing is a contrast with major central banks around the world, which from China to India to the U.S. are withdrawing liquidity from their banking systems. Policy makers in Australia, Malaysia and Vietnam have started raising interest rates.

The central bank unveiled the lending program for commercial banks in December after the yen surged to a 14-year high and government officials including Finance Minister Naoto Kan urged the bank to do more to stem deflation.

BOJ officials who have spoken publicly since the last meeting have indicated they haven’t changed their views of the economy. Board members Miyako Suda and Tadao Noda said in the past week the economy will keep improving and its upside and downside risks are almost balanced.

The government said today it nominated former Tokyo Electric Power Co. executive Yoshihisa Morimoto to join the central bank’s policy board, filling its last vacancy.

Recovery Intact

Since Shirakawa and his colleagues last met, reports for January have shown the export-led recovery remains intact, backing up the central bank’s assessment that the economy is “picking up.” The unemployment rate dropped to a 10-month low of 4.9 percent and wages climbed for the first time in 20 months. At the same time, there are signs deflation may be worsening: a report yesterday showed the gross domestic product deflator, a broad gauge of prices, tumbled a record 2.8 percent last quarter.

Kan said yesterday he wants to stamp out deflation as soon as this year. Last week, he reiterated his call on the central bank to target inflation of about 1 percent or higher.

“The BOJ probably wants to dodge political pressure by modifying the existing facility and avoid any extraordinary steps such as inflation targets and more government bond purchases,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “If the BOJ does something, the government can claim to the public that they influenced the move, even if it’s a cosmetic change.”

To contact the reporters on this story: Masahiro Hidaka in Tokyo at mhidaka@bloomberg.net; Mayumi Otsuma in Tokyo at motsuma@bloomberg.net