Bank of Japan Governor Masaaki Shirakawa pledged to keep monetary policy easy to help pull the country out of deflation, reassuring the government, which has been pushing the central bank to do more to support the economy.
In his first public appearance since Naoto Kan became finance minister on Jan. 6, Shirakawa on Monday stuck to the bank's official line on policy and offered few clues on whether further monetary easing was on the horizon.
But he repeated the BOJ's determination to beat deflation by maintaining very low interest rates, a stance that has recently won praise from Kan.
"The BOJ recognises that it's very important for Japan's economy to pull out of deflation and return to sustainable growth with price stability," Shirakawa said in a speech to the central bank's regional branch managers.
Kan said the government would also strive to overcome deflation and ensure an economic recovery.
"Looking ahead, there are risks such as a further worsening of the employment situation and deflation, and the foundations for the economy to return to a strong, private demand-led growth path remain fragile," Kan said on Monday in his first speech to parliament as finance minister.
The BOJ is expected to keep interest rates near zero and hold off on new policy initiatives at its policy-setting meeting on Jan. 25-26.
The central bank will also review its long-term growth and price forecasts at the meeting, although no major changes to them are expected.
Shirakawa stuck to the BOJ's assessment of the economy, saying it was picking up, with exports and output on the rise, although domestic private demand lacked momentum.
The BOJ is forecasting three years of price falls and has said it will not tolerate zero inflation, let alone deflation, effectively pledging to keep rates near zero for as long as necessary.
Kan, a heavyweight of the ruling Democratic Party, has been one of the most vocal cabinet critics of the BOJ and is seen as more interventionist on monetary policy than his predecessor, who stepped down for health problems.
As economics minister, Kan led the government to declare in November that Japan was in deflation. Ten days later, the BOJ did an about-turn and used the same word, having avoided it until then on the grounds that the definition was vague.
On Dec. 1, a few days after Kan said the government and the BOJ would act to stem yen rises, the BOJ eased policy with a new scheme offering banks more short-term funds. The move drove the yen away from a 14-year high hit against the dollar in November.
Since then, Kan has toned down his criticism toward the BOJ, a sign he was satisfied with the bank's moves, at least for now.
He said last week the government and the BOJ were working well together to beat deflation, and that the government must respect the central bank's independence.
But BOJ officials believe Kan will pressure the bank for further monetary easing if the economy falters, and so they are mulling what steps they have left, with rates already very low.
Officials are considering buying more government debt or increasing the easy money the bank can make available via an expansion of the fund-supply operation put in place in December.
Japan emerged from recession in the second quarter of 2009 with support from government stimulus and solid exports to Asia.
Firm exports and output have led four out of nine regions in Japan to revise up their assessment in the BOJ's quarterly report on the regional economy. The five others kept their assessments intact in the report, issued on Monday.
But deflation was spreading across various sectors of the economy as consumers favoured cheaper goods, the report said.
Deflation hurts corporate profits because households hold back on spending on hopes that prices could fall further.
If expectations of price declines erode demand too much, companies could cut prices below cost and cover losses by slashing jobs, making consumers even less willing to spend.
The BOJ is virtually alone in expanding monetary easing. The Federal Reserve and the European Central Bank have said they will start phasing out their emergency lending and liquidity facilities in light of improvements in credit markets.
While the BOJ is independent by law, the government wields influence over monetary policy by picking candidates for the bank's nine-person policy board, including its governor.
Representatives from the finance ministry and Cabinet Office attend the BOJ's policy-setting meetings. They cannot vote but can voice their views and request delays in votes.
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