Tokyo, March 19 (Bloomberg) -- The Bank of Japan said it will pushinterest rates close to zero and told government policymakers they willnow have to do their share to stop the economy sinking into recession. The move comes three weeks after the central bank cut its key interbanklending rates 10 basis points to 0.15 percent. Together, that takes backthe quarter-point increase Bank of Japan Governor Masaru Hayami drovethrough in August last year, arguing the economy was in good enoughshape to stand higher borrowing costs. ``The ball is back in the court of the politicians,'' said Andrew Milligan,global strategist at Standard Life Investments in Edinburgh, Scotland,which manages 80 billion pounds ($116 billion). ``The politicalestablishment has got to make some very difficult decisions.'' With rates now pared to the bone and the government constrained by adebt expected to reach 130 percent of gross domestic product next yearfrom spending its way out of trouble, pressure is on lawmakers to forcebanks to close down ailing companies that owe about 33 trillion yen theycan't repay and open domestic industries to competition. The bank said such reform won't be easy. ``Structural reform may beaccompanied by painful adjustments,'' it said in a statement. ``Withoutsuch adjustments, neither improvement in productivity nor sustainableeconomic growth can be obtained.''
`Drastic Steps'
The bank also changed its view of the economy from that it gave in August,when it raised interest rates for the first time in a decade. ``The bank has come to the conclusion that economic conditions warrantmonetary easing as drastic as is unlikely to be taken under ordinarycircumstances,'' the BOJ said. To lower rates, the BOJ will increase the reserves held by commercialbanks at the central bank to 5 trillion yen ($40 billion) from 4 trillion yen.The BOJ will infuse more cash into the money market to enable banks tomeet the new target. The extra cash will push down the cost of borrowingfrom close to zero from the current 0.15 percent. ``They increase the reserve requirement by 1 trillion yen and then lendback to the market 1 trillion yen,'' said Carl Weinberg, chief economist atHigh Frequency Economics in Valhalla, New York. That's just``poppycock, and not nearly the quantum leap of money supply theeconomy needs to start growing again.''
Buy More Bonds
The central bank said it may increase the amount of bonds it buys frominvestors each month from the current 400 billion yen, if necessary, thoughit won't buy bonds directly from the government. The new policies will bekept until consumer prices, excluding fresh food, stabilize at or above zeropercent. ``The central bank basically did what it could,'' said Yukari Sato, a senioreconomist at Nikko Salomon Smith Barney Ltd. ``It's more than just goingback to the zero interest rates policy. They've finally come to doquantitative easing.'' The benchmark Nikkei 225 stock index fell 0.3 percent today. The index isdown 41 percent this fiscal year, reaching a 16-year low last week. Themarket closed before the BOJ announcement. Banks have used unrealized profits on their vast stock holdings to offsetbad loan write-offs. New laws from April will require banks to value thosestock holdings at market price for the first time. That requirement, analystssay, means some banks are close to reporting losses. That's straining their ability to lend, starving the economy of the freshmoney it needs to grow. Japan's main gauge of money supply rose 2.7percent in February from a year ago, less than half the pace of moneysupply growth in the U.S., and bank lending has fallen for almost threeyears.
Back to Zero
The yen initially fell to 123.46 to the dollar after the BOJ announcement, itslowest since May 1999. It was recently at 122.04 to the dollar after Hayamisaid at a press conference he sees no reason to steer the yen lower tohelp the economy. Bond futures rose to a record after the bank said it may buy more bonds. The central bank first cut rates to near zero two years ago, and kept themthere until August last year, when rates were raised for the first time in adecade. Then, Hayami said the economy was recovering and was nolonger threatened by deflation. Now, the government says the economy isthreatened by falling prices. Investors said it was a mistake to raise rates. ``The economy was alreadyon the verge of recession when the BOJ abandoned its zero interest ratepolicy,'' said Hajime Yagi, a senior portfolio manager at Meiji DresdnerAsset Management Co., which handles $1 billion in stocks. ``A return tothe zero rate policy now will do little to change the situation.''
Fed Rate Cuts
Japan's industrial production had its biggest decline in more than five yearsin January, and exports to the country's three major markets -- Asia, theU.S. and Europe -- fell, handing Japan its first trade deficit in four years. There may be some relief from the U.S. soon. The U.S. Federal Reservewill probably cut its benchmark rate at least half a point Tuesday. Most ofthe 25 investment firms that trade government securities directly with theFed expect policy makers to lower the overnight bank lending rate to 5percent from 5.5 percent. Ten of the dealers predict a cut to 4.75 percent. Investors hoping the latest economic reversal will prod the government totake unpopular economic reform may be disappointed. Instead, thegovernment appears to be contemplating a traditional Japanese way out ofslowing growth -- spending up big. Taichi Sakaiya, the former chief of the Economic Planning Agency, told theNihon Keizai newspaper the government will probably need to spend anextra 3 trillion yen in the fiscal year starting April 1 to kick-start theeconomy.