Tuesday August 14, 6:04 am Eastern Time

Bank of Japan further eases ultra-loose
policy

By Ritsuko Ando

TOKYO, Aug 14 (Reuters) - The Bank of Japan surprised financial markets on Tuesday by loosening its already ultra-easy credit policy in a bid to pull Japan from the edge of recession and soften the pain of the prime minister's pledged reforms.

The central bank expanded its so-called quantitative easing policy, its fourth easing this year, by promising more funds to boost bank reserves and by increasing the amount of Japanese government bonds (JGBs) it buys monthly from the market.

``The global economy is falling at a stronger pace than we had previously thought,'' BOJ Governor Masaru Hayami told reporters.

``At home, share prices have been falling. Banking shares have been falling amid downgradings of their credit ratings, and investors are worried,'' he said. ``We cannot help but think that downside risks to the economy are becoming a reality.''

The easing in the central bank's unorthodox policy comes as the world's number-two economy continues to stumble despite interest rates already at zero, and a day after a dive in stock prices to new 16-year lows sparked calls by politicians for stronger BOJ action.

But many economists doubted whether the easing would be enough to rekindle consumer spending, the biggest and most persistently weak area of the economy, or translate into a fresh burst of lending by Japan's debt-choked banks.

They said the main aim was likely to help cushion the pain from reforms planned by Prime Minister Junichiro Koizumi as he grapples with an economy suffering from steady price declines,
rising bankruptcies and dwindling industrial output.

The stock market roared its approval, jumping more than four percent at one point before settling to close up 3.84 percent at 11,917.95 -- its biggest one-day percentage gain since April and snapping a four-day losing streak.

The yen dipped as low as 123.19 to the dollar after the news from around 122.38, while bond prices initially jumped to six-week highs before later stabilising.

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Analysts say the easing means the central bank is trying harder to force-feed banks with virtually free money, although it has repeatedly warned that structural problems in the banking sector were limiting the amount of funds flowing into businesses.

Some economists, noting bank lending has fallen for 43 months in a row despite ample liquidity, argue that creating more bank reserves is akin to pushing on a string because it is the demand for loans, not the supply, that is lacking.

``It's absolutely cosmetic,'' said Vincent Musumeci, economist at ABN AMRO in Tokyo. "They had to show some easing effort and this is their reaction to pressure.

``It doesn't change the fact that monetary policy is ineffective. It doesn't make any difference since rates are at zero.''

[snip]

Japan suffered unprecedented back-to-back annual declines in consumer prices in 1999 and 2000. The rate of fall has even accelerated this year, causing some officials to warn that Japan faced the growing risk of a vicious deflationary cycle.

Some politicians in the dominant Liberal Democratic Party have been calling on the BOJ to adopt an inflation target.

Hayami said that was not an option at present.

``Inflation targeting is something done by countries with inflation. I've never heard of it being done in a country with deflation,'' he said.

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