The Economist on Japan 5

The Economist on Japan 5

A hiker's guide to Japan

Feb 22nd 2007 | TOKYO
From The Economist print edition
The central bank's governor finally gets his way

IF AT first you don't succeed, try, try again. It was third time lucky for Toshihiko Fukui, the governor of the Bank of Japan (BoJ), in his bid to raise interest rates. In December and then again in January, he had failed to persuade enough of the BoJ's nine-member monetary-policy board to vote for an increase. But on February 21st, after hours of haggling with fellow members concerned about the economy's fragile recovery, he got his reward at last. The vote was eight to one in favour of raising the bank's benchmark rate by a quarter of a percentage point, to 0.5%. It has not been that high for more than eight years.

Japan's rates are still the skimpiest in the rich world, a fact not lost on international investors. They have been borrowing heavily in yen and putting the proceeds into more remunerative assets, such as antipodean bonds (see article). This carry trade, as it is called, has cheapened Japan's currency, much to the chagrin of American carmakers and European policymakers. A quarter-point rise will do little to deter the traders, but it might appease Japan's foreign critics.

This international carry-on is, however, the last thing on Mr Fukui's mind. This week was his final chance to sneak a rate rise past politicians in his own country, before a season of heavy politicking begins. The government, led by Shinzo Abe, the prime minister, faces a big round of local elections in April and a fiercely contested Upper House election scheduled for July. It did not welcome this week's decision, but it would have fought much harder against a spring hike that would have embarrassed its candidates on the stump.

As it was, Mr Abe's hatchet-men had to be restrained from the same heavy-handed methods that prevented a rate rise last time. Chastened by the global reaction, his ruling Liberal Democratic Party realised it had overstepped the mark by bullying the central bank so overtly. It will take the BoJ a long time to recover its international credibility as an independent custodian of Japanese monetary policy.

Amid all of this political teeth-gnashing, Mr Fukui has been anxious to wean Japan off its addiction to cheap money. He does not want to repeat the bank's mistakes of the 1980s, when its lax monetary policy created a bubble economy. The collapse of that bubble brought the country's banking system to its knees and condemned Japan to 15 years of deflation. To prevent anything like that happening again, Mr Fukui has insisted that the bank adopt a more forward-looking approach, instead of having to react hastily to news from the market.

A year ago the BoJ declared deflation dead and ended its five-year experiment with “quantitative easing”, which involved flooding the market with excess liquidity. Confident that the worst was behind it, the bank raised rates last July from zero to 0.25%. Ever since, the governor has been itching to raise them again—in order to return a measure of normality to monetary affairs. In Japan “normality” means steering interest rates gradually to somewhere around 2%.

The BoJ has been held back until now by the choppy state of the Japanese economy. After a particularly bleak third quarter, when it eked out annualised growth of just 0.3%, the fourth-quarter numbers announced last week came as welcome relief. For the three months to December, the economy grew at an annual rate of 4.8%, its fastest pace in three years. Much of the gain was thanks to stronger personal spending, which was up by an annualised 1.1%. This was mainly a rebound from the previous quarter, when spending fell by much the same amount. But it still cheered the BoJ no end.

The bank is counting on consumption, which accounts for 55% of Japanese GDP, to become the locomotive of the economy. Households are certainly spending what they have. According to the OECD, Japan's household saving rate has fallen by over eight percentage points since 1998, a deeper plunge than America's. The country's households now fail to dispose of just 2.9% of their disposable income.

Unfortunately, that income is not yet rising as quickly as it might. The weak yen and low interest rates have helped companies make record profits, but the money is failing to filter through into pay-packets. No longer protected by import restrictions or indulged by docile Japanese consumers, corporate Japan is feeling the hot breath of global competition on its own doorstep for the first time. Under the circumstances, companies are showing themselves remarkably reluctant to spend on anything other than productivity-boosting plant and equipment.

Thus even as Mr Fukui fears a return of the bubbly 1980s, others fret about a rerun of August 2000, when the BoJ raised rates prematurely, killing off a nascent recovery and deepening Japan's deflation. The economy has enjoyed five years of continuous growth since then—technically the longest boom since the second world war. But it is still haunted by falling prices. Excluding food, Japan's consumer inflation was only 0.1% in the year to December, down from 0.2% in November. And retreating energy costs may yet snuff out even these faint, inflationary embers.

But Mr Fukui's sights are set further ahead. He makes policy according to the inflation outlook about two years down the road. Over that period, Japan's recovering economy will surely begin to press against its supply-side limits, pushing up wages and prices. Shareholders certainly seem optimistic. After the bank's decision, the Topix stockmarket index closed at a 15-year record, hitting heights not seen since Japan's slide into deflation. Perhaps Mr Fukui's forward-looking policy has something to look forward to.