Minutes of the Monetary Policy Meeting

on October 31, 2003
(English translation prepared by the Bank's staff based on the Japanese original)

December 19, 2003
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Friday, October 31, 2003, from 9:00 a.m. to 12:15 p.m.¹

Policy Board Members Present
Mr. T. Fukui, Chairman, Governor of the Bank of Japan
Mr. T. Muto, Deputy Governor of the Bank of Japan
Mr. K. Iwata, Deputy Governor of the Bank of Japan
Mr. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma

Government Representatives Present
Mr. H. Tsuda, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance
Mr. Y. Nakajo, Director General for Economic and Fiscal Management, Cabinet Office

Reporting Staff
Mr. E. Hirano, Executive Director (Assistant Governor)
Mr. M. Shirakawa, Executive Director
Mr. A. Yamamoto, Executive Director
Mr. Y. Maehara, Adviser to the Governor, Policy Planning Office
Mr. H. Yamaguchi, Adviser to the Governor, Policy Planning Office
Mr. S. Kushida, Deputy Director-General, Policy Planning Office
Mr. H. Nakaso, Director-General, Financial Markets Department
Mr. H. Hayakawa, Director-General, Research and Statistics Department
Mr. K. Momma, Deputy Director-General, Research and Statistics Department
Mr. A. Horii, Director-General, International Department

Secretariat of the Monetary Policy Meeting
Mr. K. Akiyama, Director-General, Secretariat of the Policy Board
Mr. T. Takei, Adviser to the Governor, Secretariat of the Policy Board
Mr. H. Onobuchi, Deputy Director, Secretariat of the Policy Board
Mr. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on December 15 and 16, 2003 as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.

I. Summary of Staff Reports on Economic and Financial Developments²

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on October 9 and 10, 2003,³ and allowed some degree of fluctuation in the outstanding balance of current accounts at the Bank. As a result, it was moving at the 29-31 trillion yen level.

Reflecting these market operations, the weighted average of the uncollateralized overnight call rate was moving in the 0.001-0.002 percent range, except for October 14 when the rate was minus 0.003 percent against the background of the temporary increase in the negative cost of funding yen in exchange for the U.S. dollar. Bid rates on funds-supplying operations were stable overall reflecting the confidence about financing in the money market.

B. Recent Developments in Financial Markets

The bond market was susceptible to developments in stock prices in the intermeeting period. The yield on newly issued ten-year Japanese government bonds (JGBs) in the secondary market was recently fluctuating at around 1.4 percent. Looking at JGBs by term structure, yields on medium- to long-term bonds in particular increased. Volatility of yields on JGBs in the secondary market remained at high levels, although it had declined somewhat compared to the summer, when yields were rising. The yield differentials between JGBs and yen interest rate swaps, particularly in the medium-term zone, also remained high. As for the yield differentials between JGBs and corporate bonds in the secondary market, those for bonds with low credit ratings narrowed slightly. This suggested that investors were taking a stance of actively purchasing corporate bonds.

The Nikkei 225 Stock Average marked a new high for 2003 on October 20, and then plunged reflecting factors such as market participants' cautiousness about high stock prices. Recently, however, it was recovering as investors were buying stocks on dips. As for trading by type of investors, foreign investors had turned net sellers of Japanese stocks very recently, but their view that Japan's economy would move toward a gradual recovery seemed unchanged. As for individual investors, margin purchases were increasing markedly.

The yen was traded in the 108-111 yen range against the U.S. dollar, its highest range in 2003 to date. Around the end of October, depreciatory pressure on the U.S. dollar had increased mainly for the following reasons. First, market participants were testing the Japanese authority's stance on foreign exchange intervention. Second, Japanese exporters had adjusted their expected exchange rate to take account of the depreciation of the U.S. dollar. And third, market participants were skeptical about an improvement in the employment situation in the United States. However, the extremely bearish market sentiment with respect to the U.S. dollar seen in late September seemed to have abated somewhat.

C. Overseas Economic and Financial Developments

The U.S. economy had stayed on a modest recovery trend supported by household spending. The advance estimate for U.S. real GDP growth in the July-September quarter was high at 7.2 percent on an annualized quarter-on-quarter basis, exceeding market expectations. Looking at demand components, the growth of private consumption was high due to positive effects of tax cuts, and business fixed investment, particularly IT-related fixed investment, grew at a faster pace. The rate of increase in the private consumption deflator rose reflecting a rise in services prices.

In U.S. financial markets, stock prices rose until mid-October following the release of favorable financial results by firms. However, they were fluctuating recently, partly due to profit-taking sales. Long-term interest rates rose in the first half of October reflecting an improvement in expectations for economic growth, but they declined slightly thereafter against the background of the weakness in stock prices. Developments in federal funds rate futures suggested growing market expectations that the target for the federal funds rate would be raised by early spring of 2004.

In the euro area, the overall economy was bottoming out, as exports were recovering and this was starting to have a positive impact on production.

In European financial markets, as in the United States, stock prices and long-term interest rates rose in the first half of October, then declined somewhat. In the United Kingdom, long-term interest rates were on a rising trend reflecting growing market expectations that the Bank of England would raise official interest rates in the near future. Developments in EURIBOR futures factored in to some extent market participants' expectations that the European Central Bank (ECB) would raise key interest rates around spring 2004.

In East Asian economies, economic recovery was gaining strength. In China, both domestic and external demand was strong. In ASEAN economies, domestic demand was firm, although exports were slightly weak due to competition with China.

D. Economic and Financial Developments in Japan

1. Economic developments

The following indicators for September were released in the intermeeting period: trade statistics, indicators relating to private consumption, the Indices of Industrial Production, and indicators relating to prices. These indicators confirmed the following developments in the economy. First, exports had started to increase again. Second, the increase in exports was leading to recovery in production. And third, the improvement in economic activity was gradually spreading to small firms, especially in the manufacturing sector.

Real exports were more or less flat in the April-June quarter, but started to increase markedly in the July-September quarter, especially those to East Asia. By type of goods, exports of IT-related goods and of capital goods and parts increased significantly reflecting the recovery in global IT-related demand.

Indicators relating to private consumption were mixed due partly to the lingering summer heat. Sales at department stores and supermarkets, especially of autumn apparel, were generally sluggish. Sales of electrical appliances, on the other hand, rose considerably in September, following an increase in August, due to a pickup in sales of air conditioners and refrigerators as well as the upward trend in those of personal computers.

With regard to the employment and income situation, the pace of decline in nominal wages continued to slow. Special cash earnings, which reflected developments in summer bonuses, declined slightly in the June-August period by 0.4 percent on a year-on-year basis, although they had been revised upward to some extent from the preliminary figures. The ratio of job offers to applicants continued a gradual uptrend in September, and the unemployment rate stayed unchanged from August at 5.1 percent.

Industrial production increased by 3.0 percent in September from the previous month, and by 1.1 percent in the July-September quarter from the previous quarter. The production forecast index showed a substantial increase for both October and November, but it seemed unlikely that industrial production would increase as forecasted. Information obtained from corporate interviews, however, suggested that firms' extremely cautious stance on production was gradually changing recently.

The September survey by the Japan Finance Corporation for Small Business (JFS) showed that the figure for business fixed investment planned for fiscal 2003 by small manufacturers was fairly high, indicating an increase of 13.1 percent from the actual investment in the previous year.

With regard to price indicators, import prices for September were more or less flat, as their increase on a contractual currency basis, which reflected price developments in international commodity markets, was offset by the appreciation of the yen. Domestic commodity prices had been relatively strong recently due to the continuing gradual increase in prices of materials such as steel and nonferrous metals. In these circumstances, domestic corporate goods prices were virtually level in September.

The year-on-year decline in the consumer price index (CPI; excluding fresh food) for September was 0.1 percent on a nationwide basis, as in August. The preliminary figure for October in the Tokyo metropolitan area was minus 0.1 percent, a smaller decline than the previous month's minus 0.3 percent. This reflected a rise in rice prices, which increased by 11.6 percent year on year.

2. Financial environment

The issuing environment of corporate bonds and CP continued to be favorable, as evidenced by the fact that the yield differentials between corporate bonds or CP and Japanese government securities generally remained steady at low levels. As long-term interest rates were becoming more stable than they had been, some firms, which had been taking a wait-and-see attitude, resumed issuance of corporate bonds.

The year-on-year growth rate of the monetary base continued to be around 20 percent, mainly due to the increase in the outstanding balance of current accounts at the Bank. The year-on-year growth rate of the money stock continued to be around 2 percent. The shift of funds to JGBs and financing bills seemed to be behind the contraction in the growth rate in September to 1.8 percent from the previous month's 2.0 percent.

The Bank's Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks for the July-September quarter showed the following developments. Regarding the diffusion index indicating demand for loans from firms, the net percentage of respondents selecting "weaker" declined substantially. One of the factors behind this was an increase in demand for funds to open new stores and for operating funds in line with growth in sales. As for demand for loans from households, the net percentage of respondents selecting "stronger" was increasing, mainly due to a surge in demand for housing loans ahead of the expected rise in housing loan interest rates. Banks had not recently changed their lending attitude substantially, but they seemed to be shifting their policy more toward increasing the volume of loans in the near future. With regard to terms and conditions of loans, banks slightly eased their stance on spreads of loan rates and premiums charged on riskier loans.

In this situation, the lending attitude of financial institutions as perceived by firms in the survey of small firms conducted by the National Life Finance Corporation continued to improve. Furthermore, according to the survey conducted by the JFS, firms perceived their financial position as having improved to levels above the previous peak in July 2000.

The various indicators above suggested that the easiness in corporate finance was spreading.

2Reports were made based on information available at the time of the meeting.
3The guideline was as follows:
The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 27 to 32 trillion yen.
Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

II. Summary of Discussions by the Policy Board on Economic and Financial Developments

A. Recent Economic and Financial Developments

On the state of Japan's economy, members agreed that economic indicators released in the intermeeting period showed clearly that exports and production were increasing, and that economic developments were in line with the assessment at the previous meeting that the foundation for a gradual recovery in Japan's economy was being laid. Some members expressed the view that the positive effects of the increase in exports and production, reflecting the recovery in IT-related demand at home and abroad, would gradually spread to other demand components such as business fixed investment.

Regarding overseas economies, many members expressed the view that the growth rate of the world economy would increase led by the U.S. economy, referring to the fact that U.S. real GDP growth in the July-September quarter was high. As for the U.S. economy, some of these members said that there were recently signs of stabilization in the employment situation, which had been a matter of concern. These members said that household spending remained firm due in part to the effects of tax cuts, and that positive developments were beginning to be observed in orders in the manufacturing sector and business fixed investment, particularly in IT-related goods.

Many members expressed the view that exports had started to increase again. In terms of destination, a few members said that exports of IT-related goods to East Asian economies were increasing markedly. Exports to the United States, which had been decreasing slightly until August, were also increasing in September. These members expressed the view that exports were likely to continue on an upward trend, against the background of the recovery in overseas economies.

Many members said that production, which had been flat, was starting to grow in line with the increase in exports. Some members said that judging from information obtained from corporate interviews, a gradual increase in production was expected to continue, and that the increase in exports was leading to an improvement in production.

Some members expressed the view that given the increase in exports and production, business fixed investment would be on an uptrend with the recovery in corporate profits. One of these members said that it was an encouraging sign that the survey by the JFS showed that business fixed investment planned for fiscal 2003 by small manufacturers was revised significantly upward.

With regard to private consumption, a few members' assessment was that the underlying trend seemed to be unchanged, although indicators related to retail sales released recently were mixed. For example, sales of autumn apparel were generally sluggish, particularly at department stores, while those of electrical appliances were increasing. These members added that the improvement in consumer confidence in general and the slowdown in the pace of decline in nominal wages were positive factors that would support private consumption.

Regarding developments in financial markets, members said that the money market was stable due to the Bank's provision of ample liquidity, while bond, stock, and foreign exchange markets remained relatively unstable. With regard to the bond market, one of these members said that volatility remained high and that attention should be paid to the possible negative effects on money market rates. Some members said that future developments in the foreign exchange market required close monitoring, as an excessive appreciation of the yen could adversely affect Japan's exports and corporate profits.

A few members expressed the view that there were signs of slight improvement in the lending attitude of financial institutions. In this regard, a different member added that the Bank's Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks suggested that financial institutions were slightly easing their terms and conditions of loans. This member said that the permeation of these positive developments would be a focus of attention when assessing the financial environment.

B. Outlook and Risk Assessment of the Economy and Prices

Members discussed the standard scenario for Japan's economy and prices in the second half of fiscal 2003 and fiscal 2004 and risk factors that might cause the economy to deviate from this scenario, given that the final text of the Outlook and Risk Assessment of the Economy and Prices (hereafter the Outlook Report) was to be decided for release after the meeting.

Members agreed that the standard scenario for the economic outlook should be as follows. First, Japan's economy was expected to gain cyclical momentum for a recovery in the second half of fiscal 2003, and it would continue to recover during the course of fiscal 2004. And second, however, since there still remained structural impediments such as excess debt, the pace of recovery would most likely be moderate.

One member expressed the view that economic activity deviated slightly above the standard scenario in the Outlook Report released in April 2003, as uncertainty about the world economy, including that stemming from the situation in Iraq, had subsided to a large degree since the summer, and the increase in global IT-related demand was becoming clearer. Other members expressed similar views, adding that business fixed investment in Japan had started to increase earlier than expected. A different member said that the following were expected to provide momentum for economic developments in the foreseeable future. First, the considerable progress in adjustment of excess debt and capital stock, particularly at large manufacturers. And second, the progress in nonperforming-loan (NPL) disposal by financial institutions, and the positive effects of the rise in stock prices on their capital.

As for the outlook for prices, most members expressed the view that, given that the current output gap was still wide, the CPI (excluding fresh food, on a nationwide basis) would continue to register small declines in fiscal 2003 and 2004, although the moderate pace of economic recovery suggested that the output gap would narrow marginally through fiscal 2004. One of these members said that temporary factors related to changes in the social system had been pushing prices up during fiscal 2003, but in fiscal 2004 the year-on-year rate of decline in the CPI was expected to become somewhat larger once such factors dissipated. Another said that future developments in prices required close monitoring, given the effects of a rise in shipping charges and of the increase in international commodity prices, and the possibility of changes in firms' price-setting strategy. A different member, on the other hand, said that, forecasts for prices would be higher if the focus was on the degree of change in the output gap rather than its level, since the decrease in the output gap would not be marginal as suggested.

As risk factors that might cause the economy to deviate either above or below the standard scenario, members raised developments in the following: overseas economies, financial markets, progress in the disposal of NPLs and the financial system, and domestic private demand.

Regarding developments in overseas economies, some members expressed the view that the sustainability of the U.S. economic recovery was the key. One of these members said that it was necessary to pay attention to the downside risk to private consumption in the United States, as the positive effects of tax cuts were expected to wane and household income was unlikely to improve given firms' persistent stance of restraining labor costs. A different member said that the increase in the U.S. current account deficit could be a risk factor for the world economy. This member added that reducing this imbalance through changes in foreign exchange rates would have significant negative effects worldwide. Therefore, balanced growth of the world economy should be brought about by an increase in domestic demand of trade partners of the United States. With regard to East Asian economies, one member said that overheating of investment and a rise in asset prices in China could destabilize the world economy, although it was an encouraging development that China, whose economic growth remained high, was becoming a more important presence in the world economy.

As for financial market developments, many members raised as a risk factor that, depending on how stock prices, long-term interest rates, or the foreign exchange rate or a combination of these three moved, they could influence economic activity considerably. With regard to financial system developments, some members expressed the view that there remained a risk that they would adversely affect corporate finance and economic activity, although concerns over the financial system had recently been subsiding, especially related to large banks, due to the progress in the disposal of NPLs and the rise in stock prices. One of these members said that the NPL problem of regional financial institutions and its effects on regional economies required close monitoring.

With regard to developments in domestic private demand, some members said that it was important to what extent momentum for economic recovery would spread to nonmanufacturers, small firms, and the household sector. One of these members expressed the view that there was a risk that polarization in the economy could intensify if business fixed investment of large firms that were pursuing globalization accelerated further the hollowing-out of Japanese industry. It was therefore necessary to pay attention to this risk in assessing the extent to which economic recovery might spread. A different member, on the other hand, pointed out that business sentiment was recovering at both manufacturers and nonmanufacturers as well as large and small firms. On this basis, this member expressed the view that if it was widely recognized that progress was being made in the resolution of structural problems such as excess debt and labor as well as the vulnerability of the financial system, firms and households might revise their expectations for economic growth upward, and this could work as the driving force of business fixed investment and private consumption. Another member added that, in order to overcome deflation, such a rise in the expected growth rate was necessary, and it was essential that firms and financial institutions make further efforts to improve their business performance.

III. Summary of Discussions on Monetary Policy for the Immediate Future

On the monetary policy stance for the immediate future, members agreed that it was appropriate to maintain the current guideline for money market operations with the target range of "around 27 to 32 trillion yen" for the outstanding balance of current accounts at the Bank. This was because economic developments were in line with the assessment made at the previous meeting, and the money market was stable. Some members expressed the view that given this guideline, the Bank should show clearly its stance of maintaining the quantitative easing policy by conducting money market operations in a flexible manner, taking market needs into account. One member said that it remained unclear what was the significance of the widening of the target range for the outstanding balance of current accounts at the Bank to conduct monetary operations in a more flexible manner, but agreed with maintaining the outstanding balance at around 30 trillion yen on average.

A different member said that some outside the Bank associated the current guideline for money market operations with developments in foreign exchange rates. This member commented that this was not so and what the Bank had to consider when evaluating foreign exchange rates in its conduct of monetary policy was how they would affect the economy and prices.

Some members commented on the Bank's commitment to maintaining the quantitative easing policy. One of these members expressed the view that providing a more detailed description of the commitment at the previous meeting seemed to have had stabilizing effects on short- and medium-term interest rates. This member added that it was important that future conduct of the Bank's monetary policy not be constrained excessively by one of the necessary conditions for terminating the quantitative easing policy, which was that many Policy Board members forecasted that year-on-year increases in the CPI would register above zero percent. A different member said that it had been appropriate to provide a more detailed description of the commitment, based on forecasts of the CPI as a necessary condition, at the previous meeting because it had contributed to stabilizing financial market expectations. In this regard, another member said that the forecasts of the CPI for fiscal 2004 in the Outlook Report to be released after the meeting would indicate that the Bank would maintain the quantitative easing policy. This member expressed the view that it was important that the Bank thoroughly explain its monetary policy stance in relation to the commitment, because market participants might make various speculations about the Bank's conduct of monetary policy as the pace of the year-on-year decline in the CPI was slowing.

IV. Remarks by Government Representatives

The representative from the Ministry of Finance made the following remarks.

(1) The government considered that the economy was showing movements toward an incipient recovery, with business fixed investment increasing and corporate profits continuing to improve. The government considered that, in this situation where the economy was expected to show an incipient recovery, the role of the Bank's conduct of effective monetary policy continued to be vital in overcoming deflation and ensuring a full-fledged economic recovery.
(2) Interest rates and exchange rates posed risks to the economy's movement toward an incipient recovery in the immediate future. An excessive rise in interest rates that preceded improvements in the economy and a rapid appreciation of the yen that did not reflect economic developments could have negative effects on economic recovery.
(3) The government would like the Bank to give due consideration to developments in the economy and financial markets, including the factors mentioned above, and conduct monetary policy flexibly.
(4) At the previous meeting, the Bank had given a more detailed description of its commitment to maintaining the quantitative monetary easing policy. The government considered that the Bank should continue to reaffirm that it would hold firmly to its stance of maintaining the quantitative monetary easing policy. In this regard, the government would like the Bank to fully take into consideration the fact that public attention was focused on the standard scenario and the forecasts for Japan's economy and prices in the Outlook Report to be released after the meeting.

The representative from the Cabinet Office made the following remarks.

(1) In the October issue of the Monthly Economic Report, the government assessed the economy as follows: "The economy is showing movements toward an incipient recovery." The government considered that it was necessary to continue to closely monitor developments in financial markets, such as exchange rates and long-term interest rates. The two most important tasks for Japan's economy were to overcome deflation promptly and to achieve a self-sustained economic recovery led by domestic demand. To this end, the government was pursuing early implementation of "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2003," which stated that deflation would be overcome after an intensive adjustment period through measures taken by the government with the Bank.
(2) In the Outlook Report to be released after the meeting, the Bank expressed the view that the output gap would narrow only marginally, and the deflationary trend would continue. The Bank again clarified its commitment based on the CPI to keep the current quantitative easing policy. The government would like the Bank to continue to conduct money market operations appropriately and flexibly by, for example, utilizing operational tools that were more effective, and at the same time pay attention to developments in financial markets. The government would also like the Bank to conduct effective monetary policy in order to overcome deflation in fiscal 2005.
(3) The Outlook Report referred to interpretation of the GDP statistics. As the GDP deflator was a Paasche index, it had a general tendency to be lower than Laspeyres price indexes, such as the CPI and the corporate goods price index. The government therefore revised the base year for the GDP statistics every five years to reflect the economic structure. The government was currently preparing for the revision in 2005 of the base year from 1995 to 2000, and also examining methods of estimating the GDP statistics, including the GDP deflator.

V. Votes

Based on the above discussions, members considered that it was appropriate to maintain the current guideline for money market operations with the target for the outstanding balance of current accounts at the Bank at around 27 to 32 trillion yen.

To reflect this view, the chairman formulated the following proposal and put it to the vote.

The Chairman's Policy Proposal on the Guideline for Market Operations:

The guideline for money market operations in the intermeeting period ahead will be as follows, and will be made public by the attached statement (see Attachment).

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 27 to 32 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

Votes for the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.

Votes against the proposal: None.

VI. Discussion on the Outlook and Risk Assessment of the Economy and Prices

Members discussed the draft of the "The Bank's View" in the Outlook and Risk Assessment of the Economy and Prices (consisting of "The Bank's View" and "The Background"), and put it to the vote. The Policy Board approved, by unanimous vote, "The Bank's View" for publication immediately after the meeting, and decided to publish the whole report on November 4, 2003.