G7 gives free hand on policy as BOJ aims to tighten

By Tamawa Kadoya

WASHINGTON (Reuters) – Group of Seven finance chiefs
endorsed the monetary tightening trend of the three major
economies at a meeting this weekend, giving a free hand to the
Bank of Japan as it seeks to lift interest rates from zero.

The G7 said in a statement after Friday’s meeting that a
strong global expansion continued, supported by improved
policies and “benign financial market conditions.”

“That was an extremely strong declaration by central
banks,” a top finance ministry official of Japan’s G7
delegation told reporters after the meeting.

Analysts said the outcome of the G7 meeting would not
likely affect the timing of a BOJ policy shift, seen as early
as July.

“The G7 statement did not say anything outright about
long-term interest rates. There will be no impact on BOJ
moves,” said Mamoru Yamazaki, senior economist at HSBC
Securities. But others said there may be some adverse effect.

“The statement about inflation being contained seems to
signal that the Fed’s tightening cycle is ending, and that
could be a deterrent for the BOJ,” said Hideo Kumano, chief
economist at Dai-ichi Life Research Institute.

As the United States nears the end of its tightening cycle
and Europe and Japan move to tighten credit, critics say an end
to extremely accommodative conditions of recent years could
disturb markets by triggering spikes in long-term interest
rates and reversing capital flows.

But central bankers at the G7 meeting said there were no
signs of such disruptive behavior and they would conduct
monetary policy to keep inflation in check.

“We all mentioned that the anchoring of inflationary
expectations, thanks to the monetary policy we are pursuing,
was pretty well observed in all major economies,” European
Central Bank President Jean-Claude Trichet said.

“We also observed that some increases in long-term rates
had also been observed in the recent period of time…but it
was not because there had been a dis-anchoring of inflationary
expectations.”

It was also the first G7 meeting after the BOJ ended its
five-year-old “quantitative easing” policy of flooding markets
with excess funds on March 9.

BOJ Governor Toshihiko Fukui presented the central bank’s
views on the policy shift and its current policy including a
new framework on medium-term price stability at the G7 meeting
on Friday and at an IMF steering committee on Saturday.

Fukui said there was some volatility in Japan’s bond market
and central banks would look out for any possible shocks on
financial markets stemming from policy shifts.

“Monetary policy can have a worldwide impact. Major central
banks are taking that into account by casting an eye out to all
over the world,” he said.

The International Monetary Fund urged the BOJ to go slowly
in removing monetary stimulus, while the United States seems
more concerned that Japan, whose economy grew 2.7 percent last
year, keeps up growth after more than a decade of economic
doldrums.

GOVERNMENT PRESSURE

Prior to the G7 meeting, verbal jawboning by the Japanese
government on the BOJ had intensified as government bond yields
surged to nearly seven-year highs.

As the biggest debtor in Japan, the finance ministry is
extremely wary of rising interest rates as it would boost costs
of funding the massive state debt, which at 150 percent of
gross domestic product is the largest among industrial nations.

Speculation of an early rate rise was partly responsible
for a rise in the yield on benchmark 10-year government bonds
to 2.0 percent, a level not seen since August 1999, before it
fell to 1.9 percent.

Finance Minister Sadakazu Tanigaki said the BOJ needed to
explain its policy better and urged the central bank to
maintain an accommodative stance.

In perhaps a conciliatory gesture to the government’s
concerns, Fukui reiterated on Friday that accommodative
conditions could be maintained if inflation was subdued.

Analysts expect the BOJ to lift the key overnight lending
rate from zero as early as July, after it finishes mopping up
excess liquidity from the money market.

A Reuters poll of 31 economists last week showed most
expect the key overnight lending rate to rise to 0.25 percent
from zero by December, although several see a move as early as
July-September.

It would be the BOJ’s first rate increase in six years.

With the G7 meeting over, markets will focus on the BOJ’s
semi-annual outlook report to be released on Friday for hints
on when the BOJ may move to end zero interest rates.

The BOJ is likely to show bullish growth and price
forecasts for this year and next, which would confirm views
that it will move to lift short-term interest rates by the end
of the year.