Japan Central Bank Cuts Key Interest Rate

The Bank of Japan shot one of the last arrows in its quiver late Wednesday when it lowered a key interest rate for the first time in three years to the rock-bottom level of 0.25%.

The move, designed to inject some hint of a pulse into Japan’s sick economic and banking systems, represents a major gamble for Japan’s central bank. If the move fails to produce results, as some critics predict, Japanese monetary authorities could lose their credibility as analysts conclude they are largely powerless.

“It’s very risky,” said Susumu Kato, chief economist with Barclays Capital Japan. “If the BOJ can’t help the markets, [the] cut will be seen as a failure and then they will have nothing left. This is very, very dangerous.”

Financial institutions and analysts said the main problem with the BOJ move is that interest rates are already so low that any stimulative impact is limited, a point that monetary officials quickly concede.

The argument in its purest form was voiced by 58-year-old Atsuko Sawada, an office worker dressed in a navy blue uniform who is now getting the equivalent of 25 cents worth of interest annually for every $100 she deposits.

“It doesn’t matter anymore,” she said. “Right now the rate is very close to zero, so what kind of impact would it have if it goes down?”

The Nikkei stock average rose 73.83 points to end this morning’s session at 14,829.37, up 0.5%, while the U.S. dollar and bond markets strengthened in New York on Wednesday after the Japanese rate-cut announcement.

In late New York trading, the dollar was worth 137 yen, up from 132.10 yen late Tuesday. In midday trading in Tokyo today, the dollar stood at 135.34.

The broader question for financial markets is whether this move by Japan represents the first volley in a round of coordinated interest rate cuts by major economic powers worldwide. Federal Reserve Board Chairman Alan Greenspan suggested last week in San Francisco that the U.S. was now more inclined to lower rates than before.

But several Japanese officials said domestic concerns weighed most heavily on Japanese central bank officials.

One of the biggest concerns that apparently prompted the Japanese central bank to finally act was the dreaded “D” word--deflation--and the threat that Japan could be dragged into a vortex of sharply falling prices similar to the Depression of the 1930s.

Over the last six months, prices in Japan have fallen 2% while personal income has declined by 1.5%. Corporate investment also fell by a sharp 10.6% in the second quarter, amid a flurry of other bad economic reports.

The central bank should get some credit for finally taking some sort of stand, knowing that it has little punch left, said Chris Calderwood, chief economist with Jardine Fleming Securities Asia Ltd.

After a protracted period of endless debate, at least one Japanese agency is making some effort to effect results, he argued. Combined with enhanced prospects of an agreement on banking legislation, he said, Japan may finally be getting into gear.

“The BOJ has tried to put [a modest] safety net in place,” Calderwood said. “The politicians are almost ready to put the high wire up. Now we’ll watch the financial institutions teeter across it.”

In theory, analysts say, lower intra-bank interest rates will help financial institutions by reducing the cost of funds. Assuming they can borrow money at a lower rate but lend at the same rate, they can improve their profit margins and increase their capital.

The Bank of Japan also hinted Wednesday that it might inject more money into the system through commercial operations. In effect, it could buy company bonds and large bank CDs, releasing more yen into the economy and in theory expanding credit.

If the interest rates end up lowering the rate that ordinary depositors get at banks, however, the government could come under further criticism even as consumer confidence is undermined still more.

“If the rate goes still lower, I won’t know how to plan my retirement,” said Mihoko Yamada, a 61-year-old housewife who was walking in Tokyo’s banking district of Otemachi. “I was expecting the interest rates to go up. I didn’t even dare to think about it going down.”

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Etsuko Kawase in the Tokyo bureau contributed to this report.