The Bank of Japan on Thursday abandoned the super-easy monetary policy it has kept for five years, saying it will gradually raise interest rates and start to cut the excess cash in the banking system amid signs of economic recovery.
But the central bank sent a clear message that the transition will be slow, saying benchmark interest rates will remain near zero for some time and that it will only gradually reduce the amount of liquidity in the financial system over several months.
“Interest rates will stay at zero for some time, then stay extremely low and go through an adjustment period,” Bank of Japan Gov. Toshihiko Fukui said a press conference. “It’s up to the economy how much and when.”
In essence, the central bank made it clear changes were coming but left policy largely unchanged for the immediate future — a move economists praised for showing decisiveness without alarming global markets.
“The bank did a splendid job,” said Yasuhide Yajima, senior economist at NLI Research Institute. “The market had expected an end to the policy, but the bank still left interest rate rises open to interpretation.”
Investors cheered the decision, lifting the Nikkei 225 index, partly because it alleviated weeks of uncertainty.
But the move also signaled that the central bank is optimistic about Japan’s economic recovery after more than a decade of stagnation — and that the bank was determined to act despite considerable political pressure to hold off.
The Bank of Japan had no easy task in timing and charting an exit from its super-easy policy.
The policy it had maintained for five years, known as quantitative easing, was unprecedented. The Federal Reserve and the world’s other central banks rely on interest rates to keep an economy in balance, including price fluctuations and growth.
But with the Japanese economy stuck in a decade-long slump and interest rates already at zero, the central bank flooded the banking system with money to spur borrowing and lending.
That policy finally seemed to be paying off with corporate profits growing, consumer spending rising and the overall economy growing at a 5.5 percent pace in the fourth quarter.
Fukui said the excess liquidity in the financial system will stay unchanged at about $255 billion (30 trillion yen) for March and reducing it to normal levels will take “a few months.”
Global markets had grown jittery in recent weeks about changes in the Bank of Japan’s policy, which had made it easy to borrow money in Japan practically interest-free and invest it elsewhere. Some investors in the U.S. feared that tighter policy in Japan would dry up that investment flow, hurt U.S. asset markets and contribute to higher U.S. rates.
Prime Minister Junichiro Koizumi and other politicians had urged the bank to proceed with caution, noting that the bank will be at fault if it’s found later to have acted too hastily.
Fukui, the bank’s chief, denied the bank faced political pressures. The board voted 7-1 in favor of abandoning the quantitative easing policy.
“We have absolutely no feeling that we acted against political opposition,” he told reporters. “We were in agreement.”
Top government officials voiced support for the BOJ’s decision.
“I believe the decision was made after ample consideration,” Koizumi said on nationally televised news. “The decision came because of signs the economy was recovering and deflation had been overcome.”
The bank also had to watch for indicators for deflation, a situation that is unusual for industrialized nations like Japan, the world’s second largest economy. Deflation saps an economy of its strength by eroding company profits, wages and growth.
The bank had said it wouldn’t alter its policy until consumer prices, which have been falling for about seven years, started to rise again. Recent data for January showed that a key index for consumer prices rose for the third straight month and marked its strongest increase since 1998.
Glenn B. Maguire, chief economist at Societe Generale in Hong Kong, said he expects the bank to hold off until December to start raising interest rates, but said the bank’s decision had been more aggressive and bold than most economists had expected.
“It’s unambiguously good news for Japan. It signals the dark days of deflation are behind us,” Maguire said.
The one surprise that came in the bank’s announcement was that board members in effect set a target for price increases, defining a flux of between zero and 2 percent in the consumer price index as desirable.
Some experts had opposed setting such numbers as robbing the central bank of its flexibility. Others had said that special factors such as surging oil prices could commit the bank to a price target that could backfire.
But analysts said the bank had kept the range wide enough, and the surprise factor was positive. Some had expected the bank to merely issue a vague statement.
“The bank made clear it’s in no hurry to raise interest rates,” said Koji Shimamoto, chief strategist at BNP Paribas in Tokyo. “That’s really positive news for markets.”