Bank of Japan extends funding steps, with eye on exit

By Hideyuki Sano
TOKYO, July 15 (Reuters) – The Bank of Japan voted to extend its corporate finance-support measures by three months, after which they could be scaled backed or scrapped if financial conditions keep improving, the head of the central bank said on Wednesday.
The BOJ board voted unanimously to keep buying commercial paper and corporate bonds from banks and keep providing long-term loans to banks at 0.1 percent interest, extending the measures it introduced to deal with a crunch in credit markets.
But the three-month extension was shorter than the six months some had expected.
“We extended them by three months instead of six because we thought current improvements in financial conditions would continue for some time, and that it would be appropriate to examine economic and financial conditions again three months later,” Governor Masaaki Shirakawa told a news conference.
The bank kept interest rates at 0.10 percent and stuck to the main scenario it outlined in April of a slow return to moderate economic growth towards the end of the year
“The BOJ can’t really get complacent and withdraw liquidity because it’s too soon, but if it continues supplying liquidity it’s operating on diminishing returns — it’s basically sending the wrong message because the economy has bottomed,” said Naomi Fink, Japan strategist at Bank of Tokyo-Mitsubishi UFJ. Financial markets had expected the BOJ to keep its special measures in place. After the BOJ’s announcement, the yen was steady around 93.54 yen per dollar, while JGB futures were little changed.

ECONOMY STOPPED WORSENING
The BOJ also said the economy had stopped worsening in its policy statement, giving a less bleak assessment than last month when it said it was beginning to stop worsening.
But it added that economic uncertainties remained high and its policy would continue to focus on downside economic risks for now.
Funding conditions for big companies have improved for the first time in eight quarters, but small firms are struggling to gain access to credit, the bank’s tankan corporate survey showed earlier this month.
“The BOJ felt it was necessary to provide some assurance about its corporate support measures, recognising that the economy is still quite fragile, as reflected in the tankan survey,” said David Cohen, director of asian economic forecasting at Action Economics in Singapore.
In addition, the economy is saddled with excess production capacity and labour after four straight quarters of contraction.
Still, the BOJ is worried that its heavy intervention in credit markets could distort the normal workings of the economy, which it says should be guided by market forces.
Its buying of commercial paper has pushed interest rates on such debt so low that some issuers have been able to borrow funds even more cheaply than the government.
The central bank’s recent offers to buy CP have attracted few bids, in another sign markets no longer need this support.
The BOJ has already achieved most of what it wanted from these steps, increasing the availability of funds and bringing down “term interest rates” such as three-month rates.
Issuance of corporate bonds surged to a record 2.29 trillion yen in June, according to Reuters data, after freezing up late last year in the wake of the collapse of Lehman Brothers.
Corporate bond issuance averaged less than 500 billion yen per month during 2002-2007, when the economy was expanding.
The three-month TIBOR rate has dropped more than 30 basis points to about 0.55 percent from 0.90 percent late last year. The yield on three-month government treasury bills has dropped to around 0.15 percent from about 0.30 percent earlier this year.

MORE VOLATILE
Shirakawa said keeping extraordinary steps in place even after conditions have improved could only make the economy more volatile. BOJ officials believe cheap funding, if left unchecked, could lead to too much corporate borrowing, which is now seen as a cause of the global financial crisis.
Many economists predict the economy will grow in April-June thanks to a rebound in output and exports from the first quarter.
So far the economy seems to be tracking the BOJ’s projection in April of a slow return to moderate growth as the world economy picks up.
Still, its recovery will remain feeble after Japan’s economy contracted a total of 8.8 percent in the last four quarters.
A rebound also depends on a recovery in the global economy as domestic demand is expected to remain weak while companies shed jobs to deal with much weaker global demand.
“I feel maybe it’s quite some time away before the central bank will consider an exit strategy as the funding environment has not improved particularly for medium- and small-sized businesses,” said Junko Nishioka, chief Japan economist at RBS.
The BOJ said the economy will contract 3.4 percent in the year to March and grew 1.0 percent in the following year, slightly lowering estimates from its forecast in April. That would be one the weakest growth outlook in Asia. (Reporting by Hideyuki Sano; Editing by Hugh Lawson)

Please click here for a graphic on financial conditions and Japan’s economic growth, and here for a graphic on the BOJ’s CP buying and CP rates.