Bank of Japan Hikes Discount Rate in Wake of Nikkei’s Sharp Drop

The Bank of Japan today announced a long-awaited increased in its central discount rate--a 1-percentage point hike to 5.25%--in the wake of the Tokyo stock market’s fourth major plunge in less than a month and another major drop in the yen’s value.

The large move, which had been expected since stocks and the yen started plunging in value after a Feb. 18 general election, was taken to “forestall inflation,” the bank said.

Word that the bank’s policy committee was meeting pulled up prices on the stock market even before the announcement was made shortly after noon.

The key 225-share Nikkei index, which plunged 1,353.20 points Monday, recovered ground to end the morning down 156.67 points, or 0.5%, at 31,106.57. The index, which had been down as much as 693.16 points in the morning session, recovered further in early afternoon trading and was down only 15.23 points at 31,248.01.

Monday’s loss, which shaved 4.15% of the value of average stock prices, was the third largest in points in the market’s history and marked the fourth time in the last month that the market had suffered a massive setback, bringing the year’s pullback to almost 20%.

The yen, which dropped 1.05 points in value Monday to finish at 153.55 yen to the dollar, regained 0.65 point to finish morning trading today at 152.90 yen. Monday’s closing marked the first time in two years and eight months that the dollar had traded for more than 153 yen.

It was the fourth time since last May that the bank had increased the rate at which it loans funds to commercial institutions, and was the largest of the four increases. Until May, the central discount rate had been 2.5%, a post-World War II low.

Implementation of the move during the trading day also was unusual.

Prime Minister Toshiki Kaifu said he expected the bank’s action to help stabilize both stock prices and the yen-dollar exchange rates, which, he said, had been moving “without regard to the real economy.” He called the move timely.

Before the central bank announced its decision, pessimism pervaded the market.

“I had the most bearish weekly strategy meeting I’ve ever had this morning,” said Andrew Ballingal, senior manager of the equities department at Barclays de Zoete Wedd in Japan. “I don’t see anything in the domestic context or the external context to turn things around,” he said.

Brokers said heavy computer sell programs contributed to the loss. Talk that some speculators had run into financial trouble and were unloading shares also unnerved the market.

Market analysts noted that the presence of the same bearish factors that have plagued the market since the start of this year: prospects of a weaker yen, higher interest rates, slower corporate profit growth and higher oil prices.

Such worries have lopped almost 20% off the Nikkei since the index ended 1989 at a record high of 38,915.87.

So far this year, in point terms, the Nikkei has suffered six of its 10 worst drops. It plunged 1,569.10 points Feb. 26, its second-biggest one-day point drop.

In percentage terms, Monday’s slide wasn’t one of the market’s top 10 declines, but it did smash through a key psychological mark.

“The fall today was really severe for the market,” said Setsuo Watanuki, a trader at Toyo Securities. “It seemed to have ripped through its resistance line.”

The dollar closed at 153.55 yen and 1.6873 West German marks Monday, versus 152.62 yen and 1.6990 marks at Friday’s New York close. It was the dollar’s highest close in Tokyo since March 12, 1987, when it closed at 153.69 yen.

Financial markets in Tokyo since January had expected the Bank of Japan to raise the discount rate to defend the yen and curb inflation. The central bank had not done so, partly due to opposition from the finance ministry, which worries that a rise would hurt the economy, and partly due to fears that a hike would damage stocks.

Global interest rates have been rising in reaction to the demand for capital to cope with events in Eastern Europe and the unification of Germany in particular. This trend, combined with the view of many market experts that Tokyo share prices remain technically overvalued, gives stock market players little hope.

“In their hearts, people don’t think the market will rebound,” Yasushi Sakamoto, a fund manager at Toyo Trust & Banking, said before the central bank announced its move. “Looking at the longer term, expectations for stock market growth are not very high.”

The pessimism has largely stayed inside Japan’s borders, however, since the country’s stock market has long been viewed as overvalued in comparison with other world markets.

The U.S. and British markets both weakened a bit in reaction to Tokyo. But West German stocks surged 2% Monday in response to the country’s historic elections won by parties favoring unification of the two Germanys.

The Sydney stock market closed firmer despite Tokyo’s steep declines. The All Ordinaries index rose 15.2 points to 1,599.7.

Hong Kong stocks closed softer in see-saw trading on a widespread market belief that interest rates will go higher. The Hang Seng index fell 6.35 points to 2,886.46, above an intraday low of 2,869 but compared to a high of 2,906.