Swap Rates Show Shirakawa Never Enacting Increase: Japan Credit

Bank of Japan Governor Masaaki Shirakawa
Bank of Japan governor Masaaki Shirakawa. Photographer: Toshiyuki Aizawa/Bloomberg

Masaaki Shirakawa may become the first Bank of Japan governor since the 1990s to finish his term without raising interest rates as entrenched deflation and the yen’s surge weaken the world’s third-biggest economy.

The 18-month overnight-index swap rate, an indication of what derivative traders expect the Bank of Japan’s key interest rate will average during the period, sank to 0.05 percent on Aug. 23, the lowest since at least Dec. 2005, and compared with the BOJ’s target rate of zero to 0.1 percent, according to data compiled by Bloomberg. JPMorgan Chase & Co. and Mitsubishi UFJ Morgan Stanley Securities Co. have pushed back estimates for an increase in the overnight lending rate to 2014 at the earliest.

Shirakawa may be forced to inject more cash into the economy as the yen’s 10 percent gain to a postwar high against the dollar in the past year endanger exports, and falling prices and wages depress consumer spending. His dilemma underscores Japan’s failure to recover from the bursting of its 1980s asset bubble after maintaining the world’s lowest borrowing costs for most of the last two decades, and the task facing incoming Prime Minister Yoshihiko Noda.

“An interest-rate increase is out of question now as long as we can see,” said Ayako Sera, a market strategist at Sumitomo Trust & Banking Co., which manages the equivalent of $317 billion in Tokyo. The fact that Shirakawa may leave without raising rates symbolizes “the abnormal situation of monetary easing has become a normal situation for us,” she said.

Next Step

Shirakawa, 61, would be the first governor since Yasuo Matsushita, who oversaw policy from 1994 to 1998, to step down without a rate increase. Shirakawa is due to leave office in April 2013. The central bank’s next step may be expanding a 15 trillion yen asset-purchase program.

Government reports this week underscored the risks for an economy that has contracted for the past three quarters. Industrial production rose less than forecast, by 0.6 percent, in July from the previous month, a release today showed. The unemployment rate increased for the second straight month in July and retail sales dropped 0.3 percent, data showed yesterday.

“There’s still a lot of room to develop and expand the asset-purchase scheme,” said JPMorgan’s chief economist in Tokyo Masaaki Kanno, who is also a former Bank of Japan official. He said purchases of exchange-traded funds, real estate investment trusts, commercial paper and corporate bonds may grow. The central bank could also lower the 0.1 percent rate the central bank pays lenders with funds in its accounts, Kanno said.

After Fed

The U.S. Federal Reserve’s pledge on Aug. 9 to keep rates at a record low until mid-2013 means it’s “incredibly improbable’” the Japan would move before then, said Kiichi Murashima, chief economist at Citigroup Global Markets Japan Inc. in Tokyo. “If the BOJ were to raise rates before the Fed, that would set off a steep surge in the yen.”

Three days after the Fed’s pledge, revised inflation data showed how changes to calculate methods will push back Japan’s exit from deflation even further. Prices excluding fresh food fell 0.2 percent in June, lower than the earlier reading of 0.4 percent inflation, after the basket for compiling consumer-price data was altered as part of a five-year review.

The BOJ will probably lower its inflation forecast for the two years running through March 2013 to close to zero when it reviews its forecasts in October, from an earlier prediction of 0.7 percent, according to Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo.

Shirakawa’s Start

Months after taking the helm in April 2008, Shirakawa was faced with challenge of steering the economy through the global financial crisis, marked by the collapse of Lehman Brothers Holdings. Six months into his term, he lowered the benchmark rate to 0.3 percent from 0.5 percent.

Schooled in economics at the University of Tokyo and then the University of Chicago under Nobel-laureate Milton Friedman, the governor has consistently warned against keeping rates too low for too long, and planting the seeds for asset bubbles. He has said such policies were in part responsible for bringing on Japan’s 1980s asset bubble.

Analysts see further easing as more likely after the yen touched a postwar high of 75.95 on Aug. 19 in New York. The yen traded at 76.68 per dollar as of 9:36 a.m. in Tokyo.

Citigroup’s Murashima says the central bank may weigh expanding the maturities of assets it purchases to lower longer-term borrowing costs.

Revising Forecasts

JPMorgan now expects the BOJ to raise rates in 2014 at the earliest, compared with its previous prediction that a move would come as soon as the second half of 2013, according to chief economist Kanno. Sumitomo Mitsui’s Mari Iwashita, chief market economist, has pushed her forecast back to the year ending March 2015 from the second quarter of 2013.

Mitsubishi UFJ’s senior bond strategist Naomi Hasegawa sees the earliest chance for policy tightening in fiscal 2014, compared with a previous projection of a move as soon as the year ending March 2014. BOJ rate increases typically lag behind the Federal Reserve by at least a year, she said.

With the BOJ’s benchmark rate already near zero since 2008, policy makers have instead been adding stimulus to the economy through a fixed-rate lending program and an asset-buying facility.

The next scheduled meeting for Shirakawa and his board is Sept. 6-7. In the U.S., Federal Reserve officials will meet for two days instead of one next month to discuss the outlook for that nation’s economy and any possible actions.

Ten-year Japanese government bonds yielded 1.02 percent as of 9:40 a.m. in Tokyo, after reaching 0.97 percent on Aug. 19, the lowest level since Nov. 9. Japanese yields are the second-lowest after Switzerland among 32 bond markets tracked by Bloomberg.

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