The Bank of Japan delivered its third shot of monetary stimulus in four months on Dec. 20, in a prelude to more aggressive action next year as it faces intensifying pressure from the country's next leader for bolder action to beat deflation.
It also signaled setting a higher inflation target at its next meeting in January, when a new government will be in place.
Shinzo Abe, whose opposition Liberal Democratic Party (LDP) won Dec. 16 election by a landslide, has put the central bank's independence on the line by repeatedly calling for a binding 2 percent inflation target, double its current price goal.
Feeling the heat, the central bank expanded its asset-buying and lending program by 10 trillion yen ($119 billion) to 101 trillion yen, a widely expected move that barely moved markets.
"I take it as that the BOJ is carrying out what we sought during the election step-by-step," Abe told a party meeting.
The incoming prime minister caused a brief stir when he said that BOJ Governor Masaaki Shirakawa had telephoned to inform him of the decision in the morning--when the policy meeting was still taking place. The LDP later said the remark was a slip of the tongue and Shirakawa told a news conference he made the call in the afternoon, after the meeting was over.
With the latest move, the BOJ has expanded asset purchases five times this year, the most frequent activity during a single year in a decade. The last time it eased so many times was in 2001, when Japan was battling a domestic banking crisis.
"The next step is inflation targeting. The BOJ will come up with something that's just enough to avoid criticism from Abe but probably not enough to avoid some sense of disappointment," said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.
"Abe is not even prime minister yet. If you look at how the BOJ is behaving, you could argue this is a loss of independence."
The BOJ now has a 1 percent inflation target in place, and defines a range of zero to 2 percent consumer inflation as a desirable level of long-term price growth.
The central bank said it would review that guideline next month. It will probably clarify that, after 1 percent inflation is in sight, it will aim to achieve 2 percent inflation.
Shirakawa admitted that Abe's request for setting a 2 percent inflation target was partly behind the central bank's decision to review its long-term price goal.
But he warned that in doing so, the BOJ would ensure that its policy flexibility was protected and take into account the fact that Japan has long suffered from deflation even as other advanced economies experienced inflation.
"We must bear in mind the fact that inflation has been low in Japan for a long time," Shirakawa told a news conference.
Shirakawa has consistently argued that setting a 2 percent inflation target would be counter-productive in a country that has not seen consumer inflation exceed 1 percent for most of the past two decades.
But Abe made a rare, direct push for a higher inflation target when Shirakawa visited the LDP's headquarters on Dec. 18, saying that the central bank must pay heed to the fact that he won an election campaigning for bolder monetary stimulus.
Abe also said that once he takes over as prime minister on Dec. 26, he would instruct his new Cabinet ministers to begin working with the BOJ on setting a shared inflation target.
GOVERNMENT ACTION ALSO NEEDED
The yen has fallen almost 9 percent against the dollar since September, as Abe's emergence as the likely next prime minister raised expectations of more expansionary policy and spending.
The dollar briefly edged up to around 84.39 yen after the BOJ's decision, but quickly slid back down as markets saw its action as lacking any surprises.
While Abe's prescription has had the desired market effect so far, pushing down the yen and driving the benchmark Nikkei stock average above 10,000 for the first time in more than eight months, analysts say pumping cash into the economy will only give it a temporary boost unless followed by efforts to lift Japan's growth potential and contain runaway debt.
Some in the BOJ, particularly officials close to the conservative Shirakawa, had wanted to delay any action until January, when there is more clarity on the new government's policies and when the central bank conducts a quarterly review of its long-term growth projections.
But that was too costly with business sentiment already slumping and companies delaying capital spending plans on weak global demand, adding to evidence that any rebound from recession early next year will be minor.
"Japan's economy is weakening further and is expected to remain weak for the time being," the central bank said, offering a gloomy assessment of the world's third-largest economy currently enduring its fourth recession since 2000.
The LDP and its coalition partner, the New Komeito, together won a two-thirds majority in the powerful Lower House that would allow them to overrule parliament's Upper House in most matters, including on any bill to revise the law guaranteeing the central bank's independence from government interference.
Abe, who plans to compile a big stimulus package to revive the economy, may use that threat to nudge the central bank into buying bonds more aggressively to finance the costs.
Shirakawa pushed back, warning that the BOJ would never buy bonds for the purpose of monetizing public debt. He also said government efforts, such as deregulation, must accompany easy monetary policy for Japan to exit deflation.
But the governor, whose five-year term ends in April next year, suffered revolt even from within the BOJ board.
Board member Koji Ishida, a former commercial banker, proposed--albeit unsuccessfully--scrapping a 0.1-percent interest paid to excess reserves financial institutions park with the BOJ, something Shirakawa has resisted doing so for fear of distorting proper market functions.
($1 = 84.2600 Japanese yen)
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