Bank of Japan's Yamaguchi says will act decisively, watching yen

The Bank of Japan will act flexibly and decisively with an eye on how rises in the yen, among other factors, are affecting the economy, a deputy BOJ governor said, signalling a readiness to ease monetary policy further if the country's recovery comes under threat.

Hirohide Yamaguchi, one of the BOJ's two deputy governors, stuck to the central bank's view that the Japanese economy will resume a moderate recovery in October-March, the second half of the current fiscal year.

But he warned of various risks to the outlook such as slowing global economic growth and Europe's sovereign debt problems, which could hurt Japan by triggering a fall in share prices and a rise in the yen as investors distance themselves from risk.

"Strong uncertainty exists on the global and Japanese economies," Yamaguchi said on Wednesday in a speech to business leaders in Matsumoto, in northwestern Japan.

"We will take flexible and decisive action when needed by closely examining economic and price developments, including how they are affected by exchange-rate moves," he said.

Yamaguchi's comments were stronger than the BOJ's recent official line on monetary policy, that the central bank would take appropriate action when needed, and underscored the bank's growing alarm over the yen's recent rise.

Authorities stepped up their warnings about yen strength after the dollar hit a four-month low of ¥78.45 last week, although markets see little chance of imminent currency intervention by the authorities. It was trading around ¥79 on Wednesday.

That puts pressure on the BOJ to loosen monetary policy further in the hope of pushing down bond yields and stemming yen rises that could hurt Japan's export-reliant economy.

"If Japan were to do something on currencies they would have to act alone this time, and may not have the firepower to move the market," said Norio Miyagawa, a senior economist at Mizuho Securities Research & Consulting.

"It is more about instilling doubt in the market at the right time. For the BOJ, the easiest options would be expanding fixed-rate lending operations or buying more JGBs."

The BOJ eased policy just days after the devastating earthquake in March by topping up a pool of funds to buy assets ranging from government bonds to private debt.

It has kept monetary policy on hold since then and raised its assessment of the economy last week, encouraged by a rebound in factory output and prospects for a recovery in business and household sentiment.

But the global economic slowdown and recent yen strength are clouding the outlook, threatening to hurt exports just as Japanese companies restore supply chains damaged by the quake.

Central bank officials concede that a renewed yen spike accompanied by sharp falls in share prices would be the most likely next trigger for further easing, as such market moves would damage a still fragile recovery in business sentiment.

But analysts doubt whether BOJ easing would have a lasting impact on markets. The IMF said in a report that the BOJ's monetary policy had a modest effect on government bond yields but no significant impact on the yen.

Still, the BOJ has expressed its readiness to act if its forecast of a moderate economic recovery comes under threat. If yen rises persist, it may ease as early as its next rate review on August 4-5, some analysts say.

Japan's economy likely contracted for three straight quarters to the end of June but is expected to grow 1.1 per cent in July-September, a Reuters poll showed.

Yamaguchi said Japanese factory output would soon return to levels seen before the quake, although he warned that any recovery in US growth would be slow while Europe's debt problems would remain a drag on the global economy for a long time.

He also said a base-year revision to Japan's consumer price index in August would push down price growth to near zero, well below the 1 per cent mark considered desirable by the BOJ.

The BOJ has pledged to keep interest rates virtually at zero until consumer inflation of 1 per cent is in sight. It is now forecasting that core CPI will rise 0.7 per cent in both the current fiscal year and next year.

Yamaguchi, a career central banker close to BOJ Governor Masaaki Shirakawa, has mostly toed the BOJ's official line on monetary policy.