BOJ FOCUS-Bank of Japan keen to avoid fight with government

Published: 28 Oct 2009 18:47:07 PST

TOKYO, Oct 29 - The Bank of Japan won't admit it, but it cares about government rebukes and is hardly spoiling for a fight. Instead, the central bank hopes to mend fences with the new administration and avert pressure for aggressive action to support the economy.

Although the BOJ is independent of government control by law, don't expect it to publicly assert its autonomy in the way the European Central Bank did in June when it came under fire from German Chancellor Angela Merkel.

By contrast the Japanese central bank wants to improve ties with the government, fearing that persistent deflation could bring pressure on it to buy more government bonds or revert to a quantitative easing policy, analysts said.

"If the economy was in good shape, the BOJ wouldn't have to worry too much about government grumbling," said Koichi Haji, chief economist at NLI Research Institute.

"Unfortunately that's not the case, so whatever bad happens to the economy might be blamed on the BOJ if it acts without the government's informal consent."

Government officials have pressed the BOJ to continue its corporate debt buying and other measures the central bank says are no longer necessary because credit markets have largely recovered from the shock of the global financial crisis.

Finance Minister Hirohisa Fujii has openly criticised the BOJ's view of the economy as being too rosy and other colleagues have warned an exit from credit markets could threaten economic recovery.

BOJ officials never admit government pressure could influence monetary policy decisions. But they do want to work closely with the government, and they have got the message that the government isn't happy about the central bank's assessment of the economy.

"What policymakers say won't affect the BOJ's decisions," a source with direct knowledge of the BOJ's thinking said.

"But the bank always takes into account various factors and the view of policymakers shouldn't be ignored."

Another source expressed a similar view. Both declined to be named because of the sensitivity of the matter.

CAVING IN TO PRESSURE

The BOJ is caught on the horns of a dilemma.

The board doesn't think its credit market intervention is worth a fight with the government, which faces upper house elections next year and is worried about rising job losses.

But it also doesn't want to give markets the impression it is caving in to government pressure, as that would cast doubt over the bank's control over monetary policy and eventually undermine confidence in the currency.

That's why Governor Masaaki Shirakawa tried at a news conference earlier this month to address the government's concerns. Ending credit market programmes that have largely outlived their usefulness is mainly a technical matter, he argued, promising the central bank would keep interest rates very low.

Whether this tactic works or not will shape the future relationship with the government led by the Democratic Party, which swept to power in an Aug. 30 poll.

The BOJ was granted independent control of monetary policy in 1998, but politicians still wield some influence over monetary policy.

Government representatives can sit in on board meetings and request delays in policy decisions, although they cannot vote.

The only time the government requested such a delay was in August 2000 when it wanted to stall a rate hike. The BOJ turned it down and raised interest rates to 0.25 percent, only to cut them to zero eight months later as the economy crumbled.

That episode weighed heavily on the BOJ's reputation and is at least one reason why it shies away from the kind of public row ECB President Jean-Claude Trichet had in June with Merkel.

Trichet told a news conference he had telephoned Merkel and won an assurance she would not challenge the central bank's policy decisions, after the chancellor said the ECB had bowed to international pressure over a credit market intervention.

The BOJ is used to coping with more government pressure. Relations with the administration were much chillier in 2000, when Japan was in the midst of a home-made banking crisis.

There is no guarantee things won't get worse.

The BOJ isn't thinking about increasing bond purchases or easing monetary policy in any way, central bank officials say. But it may have to reconsider if the economy deteriorates and pressure builds.

"I'm not sure how the BOJ would justify not doing anything beyond keeping rates near zero when it's predicting three years of deflation," said Hirokata Kusaba, senior economist at Mizuho Research Institute.

"The government may ask the BOJ to do more to beat deflation, such as by reverting to quantitative easing or implementing some form of credit easing. That's a very valid point and hard to argue against."

The BOJ is already forecasting two years of deflation and is likely to extend that to three years when it issues its twice-yearly economic outlook report on Friday.