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BOJ board splits as easing squeezes banking sector

Kuroda warns against dangers of ultralow rates, but reflationists flatly deny hikes

Bank of Japan Gov. Haruhiko Kuroda voiced concern last month about the risk of instability in the financial system if ultralow interest rates remain in place for too long.

TOKYO -- The ripple effects of the Bank of Japan's ultraloose monetary policy have exposed a fissure among policy board members.

While Gov. Haruhiko Kuroda increasingly worries about the easing policy's "side effects" that harm the banking sector, some insist on staying the course to beat deflation.

Board member Yutaka Harada, in a speech Wednesday, flatly dismissed the idea of raising interest rates as long as inflation languishes below the central bank's 2% target.

"Sometimes it is said that the market is calling for an early rise in interest rates," Harada said. "However, if the bank were to indeed raise interest rates, bond and stock prices would decline and the yen would appreciate, leading to a deterioration in firms' profits. Credit costs would increase, and financial institutions would suffer substantial damage."

For about two years, the BOJ has aimed to keep short-term interest rates at minus 0.1% and long-term rates around zero. Financial institutions have suffered under this policy, especially smaller banks. About 60% of 80 publicly traded regional banks and banking groups reported a decline in net profit for the fiscal year ended in March.

Since a rise in short-term rates could put upward pressure on the yen, many think the bank will start with long rates. Daiwa Securities chief market economist Mari Iwashita expects the central bank to boost long-term rates as early as January 2019.

The nationwide consumer price index, excluding volatile fresh food, rose just 0.7% on the year in May -- far short of 2%. The BOJ projected 1.8% inflation for fiscal 2019 in its quarterly economic outlook report in April, but the bank expects to downgrade that forecast at this month's policy board meeting.

With prices barely budging, the central bank will not shift policy in a tighter direction, Deputy Gov. Masazumi Wakatabe told Nikkei in an interview late last month.

Harada and Wakatabe, the most vocal reflationists on the nine-member policy board, see beating deflation as the top priority. Wakatabe has said the central bank should not hesitate to adopt further easing measures if Japan slides back toward deflation.

But more members of the BOJ are joining the market's call for caution about the side effects of years of ultralow rates, as the outlook for achieving 2% inflation grows hazier.

Policy board member Makoto Sakurai noted in a May speech that the central bank's mandate is to achieve price stability in order to contribute to the "sound development" of Japan's economy.

"If sound development of the economy is hindered as a consequence of a rise in prices, this will confuse the essential with the unessential," Sakurai argued.

Kuroda warned in a news conference last month of the need to watch for instability in the financial system when interest rates stay low for a long time.

As easing drags on, the central bank has paid closer attention to the side effects, a senior BOJ official said. Extended periods of low rates hurt financial institutions, making that sector another area the bank must monitor on top of the economy and prices. Support is growing within the central bank for raising rates to ease this burden if inflation holds steady at even 1%.

Another factor involves the central bank having limited policy options in an economic downturn. Lifting rates now would provide room to lower them later if the economic expansion runs out of steam.

Wakatabe said he remains aligned with Kuroda on easing, but acknowledged the possibility of breaking with him later. "I'll continue to make appropriate decisions at policy board meetings going forward," he said.

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