TOKYO, Jan 20 - Taking financial markets by surprise, the Bank of Japan eased its monetary policy on Tuesday in what analysts said was a sign of concern about the potentially harmful impact of the yen's strength on the economy. The central bank said after a two-day board meeting it would raise its target volume for current account deposits parked at the central bank to 30-35 trillion yen ($280-326 billion). The range was previously 27-32 trillion yen. Under its "quantitative easing" policy, the BOJ sets a target range for the current account reserves that banks hold at the central bank, in the hope that the funds will be lent to companies and households to spark economic activity. Current account deposits comprise bank reserves and reserves put up by other financial institutions such as brokerages.
The central bank said that while the economy was improving, the pace of recovery would likely be tempered by structural problems such as debt and deflation. It also said moves in the financial and currency markets and their impact on the economy needed close monitoring -- a likely reference to the yen's recent strength. "The bank judged it appropriate to raise the target balance of current accounts held at the bank in order to reaffirm its policy stance to overcome deflation and ensure a continued recovery," the BOJ said in a statement. The move caught the markets by surprise as recent indicators have suggested Japan's export-led recovery remained on track. The government upgraded its reading of economic conditions on Monday. The BOJ will issue its own assessment later on Tuesday. "It came as a bit of a surprise. The chances of an easing had been rising but I didn't think it would be this month," said Shuji Shirota, economist at Dresdner Kleinwort Wasserstein. "I think there were a couple of factors behind the decision. Firstly, growth in the money supply and monetary base growth have been stagnating," he said. "The second factor is the yen's strength, which has gone beyond the break-even level for many exporter companies."
INTERVENTION FACTOR
Economists said another reason for the unexpected easing may have been technical. "I think the decision was prompted by the strong yen and there were two main factors -- its impact on the economy, and the difficulty of money market operations caused by massive amounts of yen-selling intervention," said Kiichi Murashima, economic and market analysis director at Nikko Citigroup. "I think the latter might have had a larger influence on the BOJ's move this time," Murashima said. Japan spent about 20 trillion yen ($188 billion) last year to rein in the yen and traders said authorities likely intervened again recently after the yen jumped to three-year highs. The BOJ reiterated it was ready to provide funds regardless of the target if risks to financial system stability emerged. Mamoru Yamazaki, chief economist at Barclays Capital agreed the technical factor may have been behind the BOj's decision. He also said it may help achieve a political agenda. "It will also show that the BOJ is doing something, especially before the G7 meeting next month," he said. The yen, which was trading around 107.50 to the dollar before the BOJ announcement, retreated to 107.62 after the news. The Japanese currency recently traded near three-year lows of 105.70. Japanese government bonds showed a muted reaction as traders saw little direct impact on interest rates. Stocks rose slightly, building on early morning gains, and at 0500g the Nikkei average was up 1.29 percent. The policy decision was by an undisclosed majority, meaning some members had disagreed. However, the nine-member board did agree unanimously to relax criteria under which the BOJ buys asset-backed securities and commercial paper in market operations, a scheme begun in August to get more money flowing to companies. This move had been widely expected. The aim is to allow banks to offset risks in lending to small and medium-sized companies, but the scheme has yet to make an impact on money flows in the absence of a mature securitisation market in Japan. ($1=107.30 yen)//