BOJ Highly Likely To Hike Rates By Year-end

The Bank of Japan is highly likely to raise interest rates again by the end of the year, and in doing so probably won't face any resistance from Prime Minister Shinzo Abe's new Cabinet, former economy minister Heizo Takenaka said.

But pushing rates higher could endanger Japan's economy and knock back further the government's goal of conquering deflation, Takenaka told Dow Jones Newswires in a recent interview. If Abe's government wants to prevent monetary policy missteps from prolonging deflation, it should change the BOJ Law so that the central bank will make reviving inflation its top priority, not lifting Japan's low rates back to normal levels, said Takenaka, key architect of former Prime Minister Junichiro Koizumi's drastic economic reforms. Takenaka's comments came after Abe earlier this week reshuffled his Cabinet to shore up the government's falling public approval ratings. Because the new Cabinet contains fewer opponents of rate increases than the previous one, analysts speculate that, while the BOJ gave up on tightening policy this month amid global market turmoil, it may become more inclined to bolster rates in the future. The Cabinet lineup "basically is friendly to bureaucrats," Takenaka said, pointing to new Chief Cabinet Secretary Kaoru Yosano, who is known for having close ties with the Ministry of Finance. "And the BOJ, in a sense, is part of the bureaucracy." Based on his observation that the BOJ is putting policy normalization over economic growth, "I think (the bank) is 100% certain" to push short-term rates to 0.75% from the current 0.50% by the end of the year, Takenaka said. Yet, "it's clear that the BOJ shouldn't do that," Takenaka said. "Bringing rates higher while letting deflation continue may satisfy (the bank's goal of) monetary normalization but could put the economy in harm's way." "If the BOJ takes any irrational steps, it would put off by a couple of years" the ending of deflation, he said.

BOJ Responsible For Failure To Beat Deflation Last FY

The central bank's moves last year to scrap its crisis-era policy of flooding the banking sector with cash and anchoring rates around zero have been the sole cause of the government's failure to meet its official goal of beating deflation in the fiscal year ended in March, he said. "There are absolutely no other reasons than that," Takenaka said. "Why is Japan still in deflation even though its real economy is this good and crude oil prices are rising? That's because money (supply) isn't rising here." "If (the BOJ) had done what it was supposed to, Japan would have escaped from deflation in fiscal 2006," he said. "The BOJ is just like the Ministry of Finance in 1997. The MOF back then brushed aside the economy and tried to normalize fiscal conditions, and their attempts ended up in a big failure. The same thing is gradually happening here." Takenaka urged the government to change the current legal framework that he said is too vague on what the BOJ should aim at and thereby is giving the bank too much latitude in handling monetary policy. "If the BOJ doesn't commit itself (to fighting against deflation), the government would better change the Bank of Japan Law and establish a framework of policy goals" for the bank to follow, he said. "Things would be better off if the government changes the BOJ Law." The second clause of the law, which guarantees the bank's independence and defines its tasks, says monetary policy "should be aimed at, through the pursuit of price stability, contributing to the sound development" of Japan's economy. But critics say the language is too broad and opaque if not meaningless. Commenting on who should succeed BOJ Gov. Toshihiko Fukui when the governor's term runs out in March, Takenaka said, rather sarcastically, that it can be "just an ordinary person who understands economy and finance." Takenaka said he hasn't been asked by Abe or any other government officials for recommendations. Takenaka served as state minister of economic and fiscal policy from 2001 to 2005, playing a major role in privatizing Japan's mammoth postal services - Koizumi's pet project - and prompting the nation's banks to get rid of bad loans that had long crippled Japanese growth. From late 2005, he worked as internal affairs minister before he retired from politics last autumn. Takenaka became an upper-house lawmaker in 2004 on the ruling Liberal Democratic Party's ticket. He is currently a professor at Keio University in Japan.