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Economy

BOJ's rate-heavy policy already looks hollow to some

TOKYO -- Financial market players suspect the Bank of Japan's new interest rate-focused policy may not provide the firepower it initially seemed to promise, handicapping attempts to stoke price growth through the appearance of a strong hand.

The market for overnight index swaps, which exchange unsecured overnight call rates for fixed interest rates for a certain period of time, gives a sense of how the rate the BOJ applies to certain deposits could change over the coming year. The implied average OIS rate for the next 12 months fell 0.005 percentage point to minus 0.202% Wednesday, compared to the bank's minus 0.1% policy rate. As many market players expect the BOJ to cut its deposit rate in 0.1-point increments, the swap market signals expectations for just one cut over the next year.

In early July, the OIS market had the central bank cutting rates twice over a year. But those hopes sank at the end of the month, when the BOJ said it would make a comprehensive assessment of economic developments under monetary easing at the following policy meeting. Markets took this to mean the central bank was concerned about negative rates' impact on banks and insurers, and began to doubt the feasibility of further steep rate cuts.

The BOJ on Sept. 21 effectively shifted the focus of monetary easing from expanding the monetary base to moving interest rates. But market players remain doubtful about the bank's ability to cut short-term rates further.

Can't do it alone

"Even if the BOJ takes rates deeper into the negative, lending rates will have a tough time keeping up," an official at a large commercial bank said. Japanese banks' average contracted interest rate on long-term loans dropped 0.161 point between January, when the BOJ announced its negative rate policy, and July. But short-term rates, meaning less than a year, have hardly budged. Banks are reluctant to cut their short-term prime rates, the benchmark for loans to small and midsize businesses, or the Tokyo Interbank Offered Rate that underpins large corporate loans, lest they crimp returns.

The impact of monetary policy on lending rates depends partly on "financial institutions' lending attitudes," BOJ Gov. Haruhiko Kuroda told a group of media and business leaders in early September. It could therefore be tough for policy rate cuts to boost companies' bottom line along with bank lending, many in the market believe.

On Monday, when the governor met a group of business leaders in Osaka, a number of small and midsize businesses reported being unable to beef up capital investment despite lower rates due to a lack of new demand. Those enterprises "are in a significant slump," according to Hiroshi Ozaki, chairman of the Osaka Chamber of Commerce and Industry. "If this sense of economic stagnation does not disappear, meeting the BOJ's 2% price growth target will be extremely difficult," he said.

Kuroda noted in his early-September speech that "there may be a situation where drastic measures are warranted even though they could entail costs" to financial institutions, depending on economic activity, prices and financial conditions. But it is far from clear how high the "costs" of further interest rate cuts could run. Though the BOJ seems to have left its fixation on quantitative easing behind, there could be less room than thought for the central bank to wield its new set of tools, if the market is to be believed.

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