Japan Sink Rate

Japan's central bank concluded Friday that near-zero interest rates would not be enough to stimulate lending and has taken the extra step of buying corporate debt as well. But the measures are unlikely to bring the yen down from decade highs, a problem which continues to batter Japanese exporters. The central bank also made clear that for all its pro-activeness, Western economies would need to improve to brighten Japan's fortunes.

Following in the footsteps of the U.S. Federal Reserve, the Bank of Japan cut its key overnight lending rate to 0.1%, from 0.3%, in a 7-1 board vote. It also said it would temporarily buy commercial paper, or short-term corporate bonds, but did not specify how big the program would be or how long it would last.

The additional measures "were necessary for the effects of extremely low policy interest rates to prevail in financial markets and corporate financing," the Bank of Japan said in a statement.

Though the scale of the program is unclear, buying corporate debt "is quite significant because it's the most aggressive we've seen from the Bank of Japan in terms of readiness to take riskier assets," said Tokyo-based Macquarie economist Richard Jerram. Japanese companies are not as strapped for funds as those in the U.S. but the commercial paper market has struggled in the last two months, and any measures to boost liquidity are welcome, he added.

The government will also buy up to 20.0 trillion yen ($223.7 billion) in shares from banks, which have suffered heavy portfolio losses as the Japanese stock market has lost over 40.0% this year. The program is intended to ease banks' sensitivity to the stock market.

But for all these measures, the health of Japan's economy next year depends on Western economies, whose recessions have battered exports and made overseas lending tight. "Uncertainty in the outlook for the economy to return to a sustainable growth path with price stability has increased," the central bank's statement read. "Much depends on financial conditions in the United States and Europe as well as developments in overseas economies."

It is unlikely that Friday's measures will be enough to keep down the yen, whose 25.0% surge this year to a 13-year high against the dollar has eroded companies' overseas earnings. After the Fed cut rates to 0.25% this week, the yen had been a higher-yielding currency than the dollar because Japan's key rate of 0.3% had been higher than the Fed's benchmark rate for the first time in nearly 15 years.

Though the dollar's plunge below the psychologically significant 90-yen level "has provoked speculation that FX intervention is imminent," "we do not expect a return to the 2001-04 policy of rapid reserve accumulation in order to resist yen appreciation," Merrill Lynch currency strategist Daniel Tenengauzer wrote in a Friday research note. He predicted that the yen would retain its strength over the next six months and then start weakening in late 2009, as an unwinding of the carry trade faded.

The central bank said Friday that it would also increase monthly purchases of government bonds, to 1.4 trillion yen ($15.6 billion), from 1.2 trillion yen ($13.5 billion), in the first increase since 2002.