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August 31, 2006
Financial Markets Department
Bank of Japan
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For most of fiscal 2005, the Bank of Japan conducted money market operations with the target of maintaining the outstanding balance of current accounts at the Bank at around 30-35 trillion yen decided at the Monetary Policy Meeting (MPM) on January 19 and 20, 2004. This target level significantly exceeded the required reserves, approximately 6 trillion yen, to be held by financial institutions at the Bank under the reserve requirement system and other requirements.1 Meanwhile, it was decided at the MPM on May 19 and 20, 2005, against the backdrop of weaker bidding incentives by counterparties in the Bank's funds-supplying operations reflecting increased abundance of liquidity at financial institutions, to amend the proviso to add that there may be cases where the balance of current accounts fell short of the target when it was judged that liquidity demand was exceptionally weak considering such factors as responses of financial institutions to the Bank's funds-supplying operations.
Under the guideline for money market operations described above, the Bank continued to provide ample liquidity in fiscal 2005. Since summer 2005, circumstances in the financial markets for money market operations have begun to change. Up to July 2005, liquidity demand among financial institutions declined further and frequent "undersubscription" (aggregate bids falling short of offers) was observed in the Bank's funds-supplying operations, as it became more evident that concerns about financial system stability abated further with the full removal of the blanket deposit insurance in April 2005. In this situation, in early June, end-July, and early August, the outstanding balance of current accounts temporarily fell below 30 trillion yen for a total of 6 business days, as the amendment to the proviso at the May 2005 MPM was applied. After August 2005, however, prospects of a rise in interest rates emerged reflecting heightened views that the monetary policy framework would be changed. Against this background, bidding by financial institutions to the funds-supplying operations gradually began to recover and the outstanding balance of current accounts was steadily maintained within the target range.
At the MPM held on March 8 and 9, 2006, the Bank decided to change the operating target of money market operations from the outstanding balance of current accounts at the Bank to the uncollateralized overnight call rate, and to encourage the uncollateralized overnight call rate to remain at effectively zero percent. At the same time, the Bank announced that the outstanding balance of current accounts at the Bank will be reduced towards a level in line with required reserves over a period of a few months.
After this change, up to the end of the fiscal 2005, the uncollateralized overnight call rate remained at an extremely low level, as the outstanding balance of current accounts was maintained at around 30 trillion yen. On the last business day of fiscal 2005, the uncollateralized overnight call rate was 0.004 percent, an extremely low rate for a fiscal year-end. Up to the end of April 2006, the call rate remained at effectively zero percent, even after the outstanding balance of current accounts began to be gradually reduced from the beginning of April.