Credit Herald

Japan’s central bank chief escalated pressure on Prime Minister Yukio Hatoyama to contain the world’s largest debt with a warning that investor “trust” won’t be assured in the aftermath of Greece’s budget woes.

“It’s important to gain the trust of financial markets by showing a path for fiscal consolidation,” Governor Masaaki Shirakawa said in Tokyo yesterday. He spoke after his policy board kept interest rates, the level of its government-bond purchases, and bank-lending programs unchanged.

Shirakawa’s remarks reflect his concern that increasing the Bank of Japan’s debt purchases risks giving investors the impression that it is willing to fund fiscal expansion. They also highlight rising tension with political leaders after Finance Minister Naoto Kan this week stepped up heat on the BOJ to fight deflation by saying Japan needs an inflation target.

“Shirakawa wants to give a fresh reminder that Japan will lose trust from the market if the nation uses monetary policy to support the government’s finances,” said Norio Miyagawa, a senior economist at Shinko Research Institute in Tokyo. “Basically, it’s impossible to escape from deflation with monetary policy alone.”

Credit-default swaps tied to Japan’s government bonds show an increase in risk. The cost of protecting the debt from default for five years has doubled to 78.8 basis points since the Hatoyama administration started on Sept. 16, according to prices from CMA DataVision in New York.

Bond Yields

The yield on Japan’s 10-year bond fell one basis point yesterday to 1.315 percent, a three-week low amid the prospect of prolonged deflation.

As part of its efforts to sustain an economic recovery, the Bank of Japan unveiled a program of lending 10 trillion yen ($109 billion) to commercial banks in December. It’s also buying 1.8 trillion yen in government bonds each month, and has kept the benchmark interest rate at 0.1 percent since December 2008.

“Monetary policy isn’t aimed at fiscal funding,” Shirakawa said. “It’s aimed at achieving sustainable growth under stable prices. It’s important that governments respect this stance and markets have faith in it.”

Concerns about the state of public finances in European nations including Greece have roiled global financial markets and weakened the euro.

“Increasingly, attention is being paid to fiscal developments of each country and their impact on markets, as we can see in the case of Greece,” Shirakawa said.

‘Burning House’

Central bank board member Seiji Nakamura warned this month that the government can’t ignore Greece’s fiscal woes, saying in a speech that the European country’s concerns aren’t just a “burning house on the other side of the river.”

Hatoyama’s administration has yet to detail plans to repair its finances since Standard and Poor’s warned last month that it may cut the nation’s AA rating. Kan aims to develop a fiscal strategy by June, and this week he said the government will consider overhauling the sales tax.

Hatoyama later repeated his stance that the government won’t raise the sales tax for at least four years. His Democratic Party of Japan is trying to sustain the recovery as it faces an upper house election in July.

Economic growth accelerated to a 4.6 percent annual pace in the fourth quarter, led by a trade revival that prompted exporters including Panasonic Corp. to Nissan Motor Co. to raise their profit forecasts. At the same time, the GDP figures showed deepening price declines that threaten to stunt the rebound.

Kan’s Battle

Kan has been pushing the central bank to battle deflation as his ability to bolster the recovery is constrained by a public debt that’s approaching twice the size of the economy. Shirakawa says the bank can’t spur prices on its own because adding cash to the economy isn’t enough to drive spending.

Responding to Kan’s suggestion this week of a 1 percent inflation target, Shirakawa said the central bank has already examined the relative merits of targeting and concluded that its current policy framework is the “most appropriate.”

Bank of Japan board members said in December that their “understanding” of price stability is increases of up to 2 percent, with a median of 1 percent.

Consumer prices excluding fresh food fell 1.3 percent in December from a year earlier. This week’s GDP report showed the GDP deflator, a broader gauge of prices, tumbled 3 percent in the fourth quarter, the most since records began in 1955.

Price Targeting

Shirakawa said putting too much focus on price movements may lead policy makers to overlook distortions accumulating in the economy. Targeting a certain level of prices over the short term may hamper the goal of achieving sustainable economic growth, the governor said.

The central bank reiterated yesterday that overcoming deflation is a “critical challenge” and it will “aim to maintain the extremely accommodative financial environment.”

“The governor’s comments showed that the BOJ is trying to quietly but adamantly resist” government pressure, said Kyohei Morita, chief economist at Barclays Capital in Tokyo.

“The BOJ is saying: while the government can’t implement additional expansionary policies because of its high debt, the bank can’t take the government’s place,” Morita said. “The two institutions can’t just fill in for each other.”

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