Minutes of the Monetary Policy Meeting

on June 25, 2004
(English translation prepared by the Bank's staff based on the Japanese original)

August 13, 2004
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, June 25, 2004, from 8:59 a.m. to 11:19 a.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. K. Ishii, Senior Vice Minister of Finance, Ministry of Finance
Mr. T. Omori, Deputy Director General for Economic and Fiscal Management, Cabinet Office
Reporting Staff 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. Uchida, Senior Economist, 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. K. Murakami, Deputy Director, Secretariat of the Policy Board
Mr. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. K. Masaki, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on August 9 and 10, 2004 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 June 14 and 15, 2004.³ The outstanding balance of current accounts at the Bank moved at the 32-35 trillion yen level. As a result of the market operations, the weighted average of the uncollateralized overnight call rate moved in the 0.001-0.002 percent range.

B. Recent Developments in Financial Markets

Money market rates were generally stable at low levels against the background of the Bank's provision of ample liquidity.

Long-term interest rates were recently at the 1.8-1.9 percent level, generally unchanged from the level at the time of the previous meeting, after having risen temporarily above 1.9 percent partly reflecting an improved perception of the economy. The yield differentials between Japanese government bonds (JGBs) and corporate bonds remained essentially unchanged.

Japanese stock prices had been firm against the background of expectations for further economic recovery. The Nikkei 225 Stock Average was recently at around 11,500 yen.

The yen had been appreciating against the U.S. dollar and had reached the 107.0-107.5 yen level. This was partly a reflection of the fact that the U.S. current account deficit for the January-March quarter of 2004 had recorded a historical high and geopolitical risks had been increasing.

C. Overseas Economic and Financial Developments

The U.S. economy continued to show balanced growth. Retail sales and industrial production increased significantly in May, and housing starts remained at a high level. As for the price situation, the year-on-year rate of increase in the producer price index and the consumer price index (CPI) rose in May. However, no sign of acceleration in inflation could be seen in the rate of increase in the core CPI (CPI excluding food and energy).

In the euro area, most indicators released in the intermeeting period suggested an economic recovery. However, household spending generally remained sluggish, and the momentum for economic recovery, therefore, remained weak.

East Asian economies continued to expand steadily. However, in South Korea, concern about a risk of economic slowdown started to emerge due partly to the effects of households' excessive debt and high crude oil prices.

In U.S. financial markets, market participants had already factored in a rise in the federal funds rate of 0.25 percentage point at the end of June and of over 1 percentage point in total by the end of 2004. Long-term interest rates had been essentially unchanged since mid-June. In financial markets in the euro area, long-term interest rates were moving in line with those in the United States. The policy interest rate had been raised in the United Kingdom and then in Switzerland.

In financial markets in emerging economies, developments in their stock prices and currencies and in the yield differentials between their sovereign bonds and U.S. Treasuries generally stayed in a narrow range. However, in Indonesia, the rupiah was depreciating somewhat, due partly to uncertainty about political developments.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports had been increasing steadily, reflecting the expansion of overseas economies, particularly those of the United States and East Asia, although the pace of increase had slowed compared to the rapid increase in the January-March quarter of 2004. By region, exports to the United States increased reflecting brisk automobile sales, while the increase in exports to East Asia, particularly to China, was recently at a pause. Imports decreased slightly in the April-May period, particularly those of capital goods and parts.

The Capital Investment Survey by the Japan Finance Corporation for Small Business (JFS) showed that business fixed investment by small manufacturers for fiscal 2003 increased substantially, by 16.2 percent from the previous fiscal year. In addition, business fixed investment planned for fiscal 2004 was 3.1 percent higher than actual investment in the previous fiscal year, a relatively large increase for plans formulated at the beginning of a fiscal year. The first Business Outlook Survey conducted by the Ministry of Finance and the Cabinet Office indicated a firmness in business fixed investment: plans for investment in plant and equipment increased by 19.8 percent from the previous fiscal year in manufacturing and 6.4 percent in all industries.

With regard to prices, the year-on-year rate of decline in the CPI (excluding fresh food) was 0.3 percent in May, slightly greater than the 0.2 percent decline in April. A breakdown showed that the pace of decline in prices of petroleum products slowed due to the rise in crude oil prices, while the rate of increase in prices of general services diminished.

2. Financial environment

The issuing environment for CP and corporate bonds remained favorable overall. The effects of the rise in long-term interest rates on corporate bond issuance had so far been small.

As for equity financing, issuance of convertible bonds continued to be firm. In addition, the amount of funds raised through equity issuance increased in June, after decreasing in May due to weak stock prices.

The year-on-year growth rate of the monetary base was at the 4.0-5.0 percent level. That of banknotes in circulation declined again in June, after having risen slightly in May.

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 30 to 35 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. Economic Developments

On the state of Japan's economy, members agreed that economic indicators released since the previous meeting confirmed that the economy continued to recover.

Members agreed that overseas economies were expanding steadily, particularly the economies of the United States and China.

As for the U.S. economy, a few members said that it was recovering steadily, as evident in the significant increase in retail sales and industrial production in May. A different member commented on the price situation that the pace of increase in the core CPI was slower than expected by market participants and thus there seemed to be no sign of an acceleration in inflationary expectations.

With regard to the Chinese economy, one member said that the effects of measures taken by public authorities to contain the overheating of the economy had started to appear, and the growth in the steel industry, in particular, was slowing markedly. A different member said that the measures taken so far were mainly based on administrative guidance, but there was speculation about a raise in interest rates and thus future developments required close monitoring.

Some members said that business fixed investment had been firm, and the increase in business fixed investment was spreading to small firms as seen in the following. First, according to the Capital Investment Survey by the JFS, business fixed investment planned for fiscal 2004 at the beginning of the fiscal year was higher than the actual investment made in the previous year. And second, the Business Outlook Survey also showed that firms, particularly manufacturing firms, were planning to substantially increase business fixed investment in fiscal 2004. One of these members said that business fixed investment planned for fiscal 2004 in the nonmanufacturing sector had been relatively weak in the March Tankan (Short-Term Economic Survey of Enterprises in Japan). Therefore, how this would be revised in the June Tankan would be an important factor in judging the underlying trend of business fixed investment.

As for the employment and income situation, one member said that there was a contrast in the assessment of labor market conditions between the Business Outlook Survey and the March Tankan: the Business Outlook Survey showed that firms recently perceived the number of employees as "insufficient," whereas the March Tankan showed that firms still perceived it as "excessive." This member added that the results of the June Tankan therefore warranted attention. A different member said that summer bonuses paid by large manufacturing firms were above the previous year's level and the decline in those paid by large nonmanufacturing firms seemed to be coming to a halt, and this could imply an improvement in household income in the near future.

As for private consumption, one member pointed out that the household sector recorded a net financial deficit for the first time according to the Flow of Funds Accounts for fiscal 2003, and expressed the view that developments in the propensity to consume would be the key to forecasting developments in private consumption. Furthermore, the effects of the rise in asset prices on private consumption required close monitoring.

With regard to prices, one member expressed the view that it would still take a considerable time for the CPI to register a sustainable increase year on year, partly because the effects of the narrowing of the output gap on consumer prices had not been observed clearly yet and factors that had temporarily pushed up consumer prices year on year would fall off one by one. A few members said that the outlook for the CPI depended to a great extent on the growth in labor productivity and the degree of improvement in wages. With regard to the rise in crude oil prices, a different member commented that the extent to which the rise was passed on to final goods prices and the effects of the rise on corporate profits required close monitoring.

B. Financial Developments

Many members expressed the view that the recent rise in long-term interest rates in Japan basically reflected an improvement in the perception of the economy, and financial markets were generally stable. One of these members said that developments in the markets since the previous meeting seemed to indicate that market participants had gradually been factoring in changes in the economic situation. Some members said that many outside the Bank held the view that the rise in long-term interest rates in the summer of 2003 had been to some extent due to speculation about the Bank's conduct of monetary policy, but the recent rise was not caused by that factor. A few members, however, said that there was some instability in the markets as evident in the slight increase in volatility of long-term interest rates recently. Some members added that long-term interest rates and other market developments warranted close attention since major events and releases of influential statistics were upcoming, such as the meeting of the Federal Open Market Committee (FOMC) and the June Tankan.

One member commented that, in foreign exchange markets, market sentiment was shifting to an expectation of depreciation of the U.S. dollar due partly to the increase in geopolitical risks and the U.S. trade deficit for the January-March quarter of 2004, which recorded a historical high.

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

On the monetary policy stance for the immediate future, members agreed that, based on the assessment of the current economic and financial situation, it was appropriate to maintain the current guideline for money market operations with the target range of "around 30 to 35 trillion yen" for the outstanding balance of current accounts at the Bank.

With regard to the recent rise in long-term interest rates, members agreed that the Bank's communication of matters related to monetary policy was particularly important given that the economic and financial situation was changing. Specifically, the Bank should explain as necessary that it would continue, as it had done to date, the quantitative easing policy in accordance with the current commitment based on the CPI. In addition, the Bank should communicate its assessment of the economic and financial situation as accurately as possible with a sufficient understanding of the views in the market so that market participants could understand the Bank's view. Some members said that these measures would contribute to avoiding undesirable speculation regarding termination of the quantitative easing policy.

One member said that, regarding one of the conditions in the commitment released in October 2003, that the Bank needed to be convinced that the prospective core CPI would not be expected to register below zero percent, in order to stabilize market expectations it should consider presenting a higher numerical value to more specifically express the criterion that the prospective core CPI should register above zero percent. Another member agreed that presenting a higher numerical value was worth considering, adding that the intention behind such a measure would not be to make the Bank's commitment stronger. Against this view, a different member argued that it was very likely that such a measure would greatly impair the Bank's flexibility in its conduct of monetary policy given the uncertainty about future developments in the economy and prices. A different member stressed that there was a risk that setting a higher condition in the commitment would not only be counterproductive, causing instability in financial markets, but also impair the credibility of its monetary policy.

IV. Remarks by Government Representatives

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

(1) Regarding Japan's economy, deflation, albeit moderate, persisted. Given this situation, the government considered that the role of monetary policy remained vital.
(2) The Bank had clarified its commitment to continuing the quantitative easing policy and was determined to firmly maintain it. However, there were some changes in financial markets, such as a rise in interest rates. The government would therefore like the Bank to continue conducting monetary policy flexibly, giving due consideration to developments in the economy and financial markets.
(3) The government would also like the Bank to deliberate what kind of new measures the Bank could take so that market participants would continue to expect that the accommodative financial environment would be maintained for the time being in order to prevent unnecessary disruption in the markets.

The representative from the Cabinet Office made the following remarks.

(1) The Japanese economy continued recovering steadily with improvement in the corporate sector advancing. Attention should be paid, however, to the effects on both the domestic and overseas economies of, for example, developments in crude oil prices and long-term interest rates. The price situation overall could be assessed as being still only halfway to overcoming deflation.
(2) The most important task for Japan's economy was to overcome deflation swiftly and achieve sustainable growth led by private demand. To this end, the government would pursue early implementation of "Basic Policies for Economic and Fiscal Management and Structural Reform 2004," which stated that the government intended to further accelerate and expand structural reform measures in fiscal 2004, the final year of the intensive adjustment period, and, defining the two-year period of fiscal 2005-2006 as the "concentrated consolidation period," to ensure that deflation was overcome through its policy efforts together with the Bank and focus on consolidating the foundations for new growth. As a result of these efforts, the nominal growth rate in and after fiscal 2006 was projected to be around 2 percent or higher.
(3) The Bank was determined to firmly maintain the quantitative easing policy. In this regard, the government would like the Bank to implement more effective monetary policy, including measures that would lead to more effective provision of liquidity, continuing to communicate closely with the government. The government would also like the Bank to make further efforts to enhance the transparency of the conduct of monetary policy by, for example, presenting a path toward overcoming deflation, paying due consideration to stabilization of market expectations given that public attention was focused on recent developments in long-term interest rates.

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 30 to 35 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 1).

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 30 to 35 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. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of May 19 and 20, 2004 for release on June 30, 2004.

VII. Approval of the Scheduled Dates of the Monetary Policy Meetings in July-December 2004

At the end of the meeting, the Policy Board approved the dates of the Monetary Policy Meetings to be held in the period July-December 2004, for immediate release (see Attachment 2).

Attachment 1
June 25, 2004
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by unanimous vote, to set the following guideline for money market operations for the intermeeting period:
The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 30 to 35 trillion yen.