BOJ Upgrades Economic View, Keeps Rates on Hold

The Bank of Japan upgraded its economic assessment on Tuesday, as rising exports and output raise expectations the worst of the recession is over, but its cautious tone suggested it was in no hurry to end extraordinary policy measures.

Katsumi Kasahara / AP

The central bank said the outlook for the world's No. 2 economy was largely dependent on final demand, which remains weak as companies pass on the pain to households through job cuts.

The upgraded BOJ view was expected, given recent sharp rises in factory output, but analysts saw no sign yet the central bank is looking to end extraordinary policies such as buying corporate bonds and commercial paper to aid corporate financing.

"We may be seeing a return to growth in Japan later this year so it is reasonable for the BOJ to upgrade its assessment now. It does suggest that a further move toward aggressive quantitative easing is becoming more distant," said Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors in Sydney.

"However, conditions are still terrible. It is too early for the BOJ to implement exit strategies. That is the general consensus among major central banks, because Japan and other economies are still in the midst of a severe recession."

The BOJ kept interest rates on hold at 0.1 percent at its two-day policy review and held off on any new initiatives, as widely expected.

The recession, triggered by bank failures and market turmoil that followed defaults on U.S. mortgages, has forced the BOJ and other major central banks to intervene in credit and interbank markets. There is now a global debate about when policy makers should retreat from these markets and cut stimulus spending.

For its part, the BOJ board may also discuss whether to extend its support for the corporate finance market. Central bank facilities to buy commercial paper and lend against corporate bonds expire in September.

The BOJ said in its statement that Japan's economy, after deteriorating significantly, had begun to stop worsening. 

That was a slightly less pessimistic view than last month, when it said the economy continued to worsen.

The central bank was also more upbeat about the outlook, saying the economy is likely to show clearer evidence of leveling out in the coming months. 

It was slightly more positive about Japan's financial conditions, saying that while they have generally remained tight, they were showing signs of improvement.
     
Bonds

BOJ Governor Masaaki Shirakawa is due to hold a news conference later in the day and markets study closely his views on rising bond yields, which push up corporate borrowing costs and undermine capital spending, already sinking at a record pace in the first quarter.

Any sign that Shirakawa is concerned about the bond market could fuel speculation that the BOJ may expand purchases of Japanese government debt.

Long-term bond yields have climbed across the world in the past month as investors prepare for economic recovery and more government debt sales to finance stimulus spending. There is also concern that government spending will spur inflation.

The 10-year JGB yield has risen 35 basis points this year, hitting an eight-month high of 1.560 percent last week, while U.S. Treasury yields have jumped 200 basis points to above 4 percent.

The BOJ has shown no sign of being perturbed by the spike in bond yields, seeing them more as a reflection of increasing market optimism over the economic outlook. The benchmark Nikkei 225 Average has gained more than 11 percent this year.

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The government plans to sell a record 44 trillion yen of new debt in the fiscal year to March 2010 to finance its regular and stimulus spending.

Partly reflecting concern over new issuance, the spread between two- and 20-year government bond yields has been widening since last October and hit a 3-½ year high of 183 basis points on June 2.

Bond issuance may grow as tax revenues fall short of initial forecasts due to weak corporate earnings, which may pile more pressure on the BOJ to increase its bond buying target from the current 21.6 trillion yen ($219.8 billion), analysts say.
     
Corporate Finance

The debate on whether to extend BOJ support for the corporate borrowing will probably be shaped by Japan's improving market conditions.

The average issuance rate for three-month commercial paper fell to 0.39 percent in May from a peak of 1.48 percent last November, while a BOJ offer to buy commercial paper on June 5 drew no bids at all for the first time.

Corporate bond issuance is also coming back to life, particularly for companies with high ratings. Toyota Motor is set to pay on its new 10-year bonds a coupon just 24 basis points above the benchmark government bond yield, far below a 75-basis-point premium it had to pay in February.

But firms with lower credit ratings are still struggling to sell corporate bonds.

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