BOJ Cuts Rate to 0.3%; Shirakawa Casts Deciding Vote (Update1)

By Mayumi Otsuma

Oct. 31 (Bloomberg) -- The Bank of Japan cut its benchmark interest rate to 0.3 percent in a split decision to stem damage on the economy from the global financial crisis.

Governor Masaaki Shirakawa cast the deciding vote to cut the key overnight lending rate from 0.5 percent after four of the eight board members dissented, the central bank said in Tokyo today. Fifteen of 17 economists surveyed by Bloomberg News predicted a reduction to 0.25 percent.

Shirakawa came under pressure to lower borrowing costs for the first time in seven years after Japan's currency surged to a 13-year high last week and the Nikkei 225 Stock Average slumped to the lowest level since 1982. Until now, Japan had kept rates on hold in the face of cuts by central banks worldwide, arguing that Japan's borrowing costs were already ``very low.''

``A rate cut will probably do little to prop up the economy; nevertheless the bank was probably fearful they'd be viewed as clinging to an overly rigid stance in the middle of a global crisis'' if they didn't cut, said Teizo Taya, a former Bank of Japan board member who now advises the Daiwa Institute of Research. ``The dissenters may have wanted to indicate they weren't comfortable with pressure from the government.''

The yen rose immediately after the announcement before reversing to trade at 98.53 per dollar at 2:23 p.m. in Tokyo, from 98.43 shortly before the decision.

Board members Miyako Suda, Atsushi Mizuno, Seiji Nakamura and Hidetoshi Kamezaki, all of whom have private sector backgrounds, voted against the decision.

`Increased Sluggishness'

``Increased sluggishness in Japan's economic activity will likely remain over the next several quarters with exports leveling off and the effects of earlier increases in energy and materials prices persisting,'' the bank said in a statement.

The central bank decided to begin paying interest on reserves commercial lenders hold at the bank to provide liquidity to the financial system. It also trimmed the Lombard rate, or the cost it charges for loans made directly to member banks, to 0.5 percent from 0.75 percent.

Speculation the Bank of Japan would cut rates was fueled by a Nikkei newspaper report on Oct. 29 that said policy makers were leaning toward a reduction. The chance the bank would halve its key rate rose to 60 percent today from 8 percent earlier this week, according to calculations by JPMorgan Chase & Co.

``Given the state of the economy and financial markets, this is the time to lower borrowing costs,'' said Naoki Iizuka, a senior economist at Mizuho Securities Co. in Tokyo. ``The yen has been weakening because investors already factored in a rate reduction, so it would be difficult for the BOJ to resist.''

Faltering Economy

Evidence that the world's second-largest economy is faltering mounted in the past month as the global crisis deepened. Exports climbed 1.5 percent in September, less than half of what economists expected, and industrial production tumbled for a third quarter. Reports today showed inflation eased and household spending fell for a seventh month.

``The outlook for economic activity and prices is attended by increased downside risks to economic activity but also by decreased upside risks to inflation relative to the recent past,'' the central bank said.

Shirakawa and his board had given no indication they planned to cut borrowing costs, other than to say that the board was ``flexible.'' As recently as Oct. 7 the governor said prolonging a low-rate policy may overstimulate the economy and make growth unsustainable in the long run.

Interest on Reserves

The BOJ said it will pay 0.1 percent on the reserves lenders hold at the central bank. Paying interest would discourage lenders from hoarding cash and help the bank provide more funds without worrying about the overnight lending rate falling below its target rate. The Federal Reserve adopted the measure on Oct. 6.

The bank ``has undertaken various prompt and decisive measures in providing liquidity, bearing in mind that the most important contribution a central bank can make in this situation is to ensure stability in financial markets,'' it said today.

A rate reduction may provide some relief to Prime Minister Taro Aso, who yesterday unveiled a $51 billion economic stimulus package in a bid to minimize the effect of tumbling stock prices and the surging yen on the economy.

Economic and Fiscal Policy Minister Kaoru Yosano said this week that a rate reduction would be ``symbolic'' if done in conjunction with other central banks and would show Japan is taking part in global efforts to counter the financial crisis.

Policy makers will release their forecasts for economic growth and consumer prices in a semi-annual economic outlook report at 3 p.m. Shirakawa will brief the press at 3:30 p.m.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: October 31, 2008 01:31 EDT