International | May 30 2006
By Chris Shaw (Tokyo)
Since the Bank of Japan (BOJ) announced it was ending its quantitative easing policy a couple of months ago the markets have been attempting to predict when it would be followed by an increase in official interest rates, so signalling the end of the zero interest rate policy or ZIRP.
As DBS notes, the market has focused on June as a likely date for an increase in official rates, but such an outcome remains unlikely in its view as there are processes to be observed before rates are pushed up.
The first, which has been underway since the end of quantitative easing, is the removal of excess liquidity from the banking system, a process DBS suggests is about half-way through and is likely to be completed in June.
Most likely then, according to DBS, is a period of assessment where additional data such as the next survey of business confidence, known as the Tankan, will be considered. Also seen as likely in July is Prime Minister Junichiro Koizumi announcing deflation has been beaten after more than a decade, a declaration that would open the way for the BOJ to then lift rates.
Such a move appears inevitable as while official interest rates remain at effectively zero inflation has begun to tick higher, meaning real interest rates are now negative. Factoring this in, DBS suggests the first move may be for the BOJ to announce in August, rather than October as it had previously forecast, a token increase in rates of around 0.1-0.15%.
It suggests such a move is likely to more politically acceptable, an important consideration given Koizumi is to retire in September and in August the jockeying for his position will begin in earnest. It would also make sense economically, as in the process of reducing its reserve balances the BOJ has taken as much as 20 trillion yen out of circulation.
This reduction in liquidity, in combination with a larger increase in interest rates, would run the risk of increasing the volatility in the financial markets, something the BOJ wants to avoid as the economy continues to show signs of improved economic performance.
