Minutes of the Monetary Policy Meeting

on February 16 and 17, 2005
(English translation prepared by the Bank's staff based on the Japanese original)

March 22, 2005
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 Wednesday, February 16, 2005, from 2:00 p.m. to 4:01 p.m., and on Thursday, February 17, from 8:59 a.m. to 12:00 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
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma
Mr. A. Mizuno1

Government Representatives Present Mr. I. Ueda, Senior Vice Minister of Finance, Ministry of Finance²
Mr. M. Ishii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. J. Hamano, 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. H. Yamaguchi, Director-General, Monetary Affairs Department
Mr. S. Uchida, Senior Economist, Monetary Affairs Department
Mr. H. Yamaoka, Senior Economist, Monetary Affairs Department
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, Director, Secretariat of the Policy Board
Mr. T. Kato, Senior Economist, Monetary Affairs Department
Mr. K. Masaki, Senior Economist, Monetary Affairs Department

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on March 15 and 16, 2005 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.
Mr. I. Ueda was present on February 17.
Mr. M. Ishii was present on February 16.

I. Summary of Staff Reports on Economic and Financial Developments⁴

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on January 18 and 19, 2005.⁵ The outstanding balance of current accounts at the Bank moved in the 30-35 trillion yen range. Undersubscription had been observed frequently in the Bank's market operations, as market participants were feeling even more strongly that there was an abundance of liquidity, due mainly to the further decrease in anxieties about the financial system. In this situation, in view of a substantial shortage of funds in current accounts at the Bank that was projected to occur at the beginning of March, the Bank provided funds to the market, devising various ways of conducting money market operations.

B. Recent Developments in Financial Markets

Against the background of the Bank's provision of ample liquidity, the weighted average of the uncollateralized overnight call rate was at around zero percent. Interest rates on term instruments remained steady at low levels.

Long-term interest rates had declined to the 1.2-1.3 percent level through early February, against the background that views about the outlook for Japan's economy continued to be cautious. They then started to rise, partly reflecting the rise in stock prices, and had recently been moving at around 1.4 percent.

Japanese stock prices temporarily weakened somewhat, due to the decline in U.S. stock prices and to concern over a decrease in earnings of Japanese IT-related firms, but then rose, mainly due to the rebound in U.S. stock prices. Recently, the Nikkei 225 Stock Average was moving at around 11,500 yen.

The yen had depreciated against the U.S. dollar, partly reflecting decreasing expectations for an early revaluation of the renminbi and remarks on the U.S. current account deficit by a member of the U.S. monetary authority. Recently, it was being traded in the range of 104-106 yen against the dollar.

C. Overseas Economic and Financial Developments

The U.S. economy continued to expand. Household spending and business fixed investment continued to increase, and the number of employees and other indicators on the supply side were on an improving trend. The inflation rate was rising at a slow but steady pace. As for the outlook, the economic expansion, particularly in household spending and business fixed investment, was likely to continue.

In the euro area, the momentum for economic recovery was weak, as sluggishness in production and employment persisted.

As for East Asian economies, in China both domestic and external demand continued to expand strongly. The NIEs and ASEAN economies continued to expand at a moderate pace.

Turning to U.S. and European financial markets, long-term interest rates declined due partly to the release of weaker-than-expected economic indicators. Stock prices in the United States and Europe rose, partly reflecting successive releases of favorable earnings reports by firms and the waning of speculation that the pace of rate increases by the Federal Reserve would accelerate.

In financial markets in many emerging economies, stock prices rose reflecting positive factors such as the favorable economic fundamentals, and the yield differentials between their sovereign bonds and U.S. Treasuries narrowed.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports rose slightly by 1.3 percent in the October-December quarter of 2004 on a quarter-on-quarter basis, after increasing by 0.1 percent in the July-September quarter. Exports were judged to have continued to be more or less flat given that, among other things, those of IT-related goods were weak, although those of consumer goods such as digital appliances recovered, particularly to the United States. Exports were projected to follow an uptrend, since it was expected that overseas economies would continue to expand, particularly those of the United States and East Asia, and that adjustment pressures in IT-related sectors would ease.

Business fixed investment had been on a rising trend. On a real GDP basis, it continued to increase at a moderate pace in the October-December quarter as in the July-September quarter. Shipments of capital goods (excluding transport equipment) continued to increase in the October-December quarter, up 3.1 percent from the previous quarter, following an increase of 1.4 percent in the July-September quarter. Machinery orders (private demand, excluding shipbuilding and orders from electric power companies), a leading indicator of business fixed investment, increased in the October-December quarter by 6.0 percent from the previous quarter after declining in the July-September quarter. With regard to construction investment, construction starts (floor area, private, nondwelling use) continued their uptrend, albeit with some fluctuations. As for the outlook, the increase in business fixed investment was expected to continue, since domestic and external demand, as well as corporate profits, were projected to increase.

Private consumption on a real GDP basis declined by 0.3 percent in the October-December quarter from the previous quarter following a decline in the July-September quarter. Sales at department stores and supermarkets and indicators for services consumption were somewhat weak on the whole, partly due to adverse weather. However, the number of new passenger-car registrations continued to be firm, and sales of electrical appliances, particularly digital appliances, continued to trend steadily upward. Private consumption was projected to recover gradually, as household income was expected to show signs of a gradual increase.

Production, particularly that of electronic parts and devices, continued to decline, posting a drop of 0.6 percent in the October-December quarter on a quarter-on-quarter basis, after inching down in the July-September quarter. In December, production of transport equipment dropped, partly due to the lack of steel products. As for the outlook, production was expected to gradually return to an uptrend. This was based on the projection that, although the effects of inventory adjustments in IT-related sectors would remain for some time, overseas economies would continue to grow and the foundation for a recovery in domestic demand would be solid. There was, however, considerable uncertainty about the degree of progress in inventory adjustments in IT-related sectors and about final demand for IT-related goods. Developments in IT-related sectors therefore required close monitoring.

As for the employment and income situation, job offers and the unemployment rate had been improving, albeit with some fluctuations. The number of employees was also on an uptrend. Wages were still on a downtrend in terms of the average per person, but the rate of decline had been diminishing. Special payments in the November-December period, which represented a majority of winter bonuses, increased by 1.5 percent on a year-on-year basis. Bonuses seemed to have basically stopped declining, assisted by the increase in corporate profits and the peaking out of firms' restructuring efforts. Judging from these developments and the increase in the number of employees, household income had stopped declining. While firms were likely to continue restraining labor costs, household income was expected to show signs of a gradual increase since corporate profits were increasing and the extent of excess labor as perceived by firms was continuing to fall.

On the price front, domestic corporate goods prices had been somewhat weak, mainly because crude oil prices fell back toward the end of 2004. The year-on-year rate of decline in consumer prices (excluding fresh food) was 0.2 percent in December, the same as in November. Consumer prices were projected to continue falling slightly on a year-on-year basis, because supply and demand conditions, although improving, were likely to remain loose for the time being, and also because the effects of the reduction in public utility charges were expected to increase slightly.

Based on the above developments, it was judged that Japan's economy continued a recovery trend, although there seemed to be somewhat weak movements, mainly in production, and the economy was expected to continue to recover.

2. Financial environment

The improvement in credit demand in the private sector seemed to have stopped temporarily, in an environment where firms continued to reduce their debts. The lending attitude of private banks was becoming more accommodative on the whole, and that of financial institutions as perceived by firms, including small firms, had also been improving. Under these circumstances, the rate of decline in lending by private banks had been diminishing moderately.

With regard to financing through capital markets, the issuing environment for CP and corporate bonds continued to be favorable and the amount outstanding of CP and corporate bonds issued continued to be above the previous year's level.

The year-on-year growth rate of the monetary base had been around 4.0 percent, and that of the money stock (M2+CDs) continued to be 2.0 percent. The year-on-year growth rate of banknotes in circulation had been at the 2.0-3.0 percent level.

4Reports were made based on information available at the time of the meeting.
5The 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 current state of Japan's economy, members concurred that, although the economy was still at a pause as there were somewhat weak movements, mainly in production, it continued a recovery trend. They also agreed that the economy would continue to recover.

Members agreed that the considerable uncertainty about the outlook for overseas economies had abated and they continued to expand steadily, particularly those of the United States and China.

Many members expressed the view that the U.S. economy continued to expand supported by household spending and business fixed investment. These members said that, although the growth rate of real GDP for the October-December quarter decelerated slightly to 3.1 percent on an annualized quarter-on-quarter basis compared with that for the previous quarter, mainly due to an increase in imports of crude oil and consumer goods and weakness in exports to Asian economies, household spending and business fixed investment continued to increase and employment was on a steady improving trend. A few members said that in this situation the inflation rate was rising at a slow but steady pace, and therefore the future conduct of monetary policy was attracting attention. One member added that market participants' concern about the U.S. "twin deficits" had subsided slightly, but developments in the deficits and possible effects on financial markets should continue to be monitored.

With regard to the Chinese economy, some members said that both domestic and external demand continued to expand strongly. A few members commented that the NIEs and ASEAN economies continued to expand at a moderate pace on the whole, while adjustments in IT-related sectors were seen in some economies.

A few members expressed the view that the momentum for economic recovery remained weak in the euro area.

Some members commented that crude oil prices continued to be a risk factor to which attention should be paid, although they were virtually unchanged recently albeit at high levels. With regard to the increase in crude oil prices, one member pointed out that investment in infrastructure such as oil-related plants by OPEC members, whose fiscal balances had improved, had been exerting upward pressure on the world economy through an increase in exports of capital goods from industrial countries to oil-producing countries.

Based on the projection that overseas economies would continue to expand, members agreed that Japan's exports were likely to trend upward. One member noted that the degree of recovery in global IT-related demand needed to be examined closely to assess the future pace of increase in exports, because exports of IT-related goods had been weak.

Members concurred that corporate profits were likely to continue improving on the whole partly due to the fact that while some firms in IT-related sectors had revised their profit forecasts for fiscal 2004 downward, those in materials-related sectors, whose business performance was strong, had revised their forecasts upward. Many members said that business fixed investment continued to increase, as evident from the fact that shipments of capital goods were strong and machinery orders and construction starts, leading indicators of business fixed investment, continued their uptrend. These members said that the increasing trend in business fixed investment was expected to continue as corporate profits continued to improve. One member added that business fixed investment by small firms would be promoted by the fact that insufficiency of production capacity as perceived by firms was growing in heavy industry firms, including affiliated subcontractors, whose business performance continued to be favorable, and that the lending attitude of financial institutions was becoming more positive.

With regard to private consumption, many members raised the following points as warranting some attention. First, various sales statistics and results of the Family Income and Expenditure Survey were somewhat weak. And second, the growth rate of private consumption in the GDP statistics for the October-December quarter was negative. These members, however, said that the effects on private consumption in the October-December quarter of factors such as natural disasters and the unusually warm weather were far from negligible. They also said that private consumption was projected to recover gradually, as consumer confidence continued to improve and household income was expected to show signs of a gradual increase.

Members agreed that production continued to show somewhat weak movements recently, due to inventory adjustments in IT-related sectors and a decline in production of transport equipment as a result of the lack of steel products and factory fires. As for the outlook, many members said that production as a whole was expected to gradually return to an uptrend, given that production in transport equipment and some other industries was expected to increase with the continuing expansion of overseas economies, although it seemed that the completion of inventory adjustments in IT-related sectors would take some more time.

Many members made other points regarding adjustments in IT-related sectors, with some commenting as follows. First, adjustments in IT-related sectors had not been as large as those at the time of the bursting of the IT bubble in 2001, judging from developments, for example, in demand for semiconductors and in business fixed investment in IT-related sectors. Second, although the adjustments in different types of IT-related goods would peak at different times, overall, adjustments were likely to be completed in spring or summer 2005. And third, the stance on business fixed investment in IT-related sectors varied by firm depending on the outcome of their business strategies, and with regard to future investment, firms were keen to make proactive investment in order to restructure their business. One member said that effects on the macroeconomy of developments in business fixed investment of and employment at firms with poor business performance needed to be monitored closely, although they had not been conspicuous yet.

With regard to the employment and income situation, many members concurred that it was becoming clear that household income had stopped declining, since the number of employees was on an uptrend and wages had almost stopped falling while indicators reflecting labor market conditions, such as job offers and the unemployment rate, continued to improve. One member said that further evidence that the employment situation was improving was provided by signs of recovery in the number of new graduates, particularly college graduates, firms had recruited and the fact that some firms were considering rehiring former employees and those reaching retirement age.

Some members commented on the overall economy that although economic statistics were slightly weak, the sentiment of management was relatively strong and did not seem to be deteriorating so much. One member said that this reflected the following factors. First, corporate profits in materials-related sectors and some other sectors where demand was solid continued to be strong, although production volume was not growing in these sectors due to their limited spare production capacity. Second, the business strength of firms, particularly their financial strength, was improving. And third, with the enhanced soundness of the financial system, concern that the economy might falter due to a spiral of deterioration in economic activity and on the financial side had diminished.

On prices, members said that domestic corporate goods prices had recently been somewhat weak, mainly because crude oil prices fell back toward the end of 2004 and the rate of decline in final goods prices such as those of machinery had increased. As for the outlook, they agreed that domestic corporate goods prices were likely to be somewhat weak or flat for some time, although developments would depend on commodity prices at home and abroad.

As for consumer prices, many members said that, when calculated excluding public utility charges and a few other items, the year-on-year rate of decline had basically been diminishing reflecting the recovery trend of the economy, but the pace of reduction had been moderate due to the improvement in productivity and the continuing tendency of firms to restrain labor costs. On this basis, these members expressed the view that the year-on-year rate of decline in the consumer price index (CPI) was likely to increase slightly for the time being, partly due to the effects of the lower fixed telephone charges and the reduction in electricity charges in preparation for the further liberalization of the electricity market in April 2005.

A few members said that it was necessary to monitor carefully the effects of the economy's being at a pause for some time on the pace of improvement in supply and demand conditions, and the effects of the pace of improvement in supply and demand on developments in prices. One member pointed out that the strength of the momentum for economic recovery after the completion of adjustments in IT-related sectors was important when assessing future price developments. Some members said that the slowdown in the pace of decline in the GDP deflator was a point that should be considered when judging the underlying trend of prices, although the slowdown might have been caused by special factors.

B. Financial Developments

On the financial front, some members said that financial markets remained extremely stable against the background of the Bank's provision of ample liquidity. One member added that it was clear that financial markets were recently more stable than around the same time of year in 2002, just before the partial removal of blanket deposit insurance. A different member noted that attention should be paid to the effects, particularly on financial institutions' profits, of the fact that interest rates on instruments with relatively long maturities were stable at low levels due to quantitative easing having been in place for a long time.

Some members said that stock prices and long-term interest rates had recently been stable on the whole, and that they had generally stayed in a narrow range even after the release of the GDP statistics.

A few members pointed out that long-term interest rates worldwide were stable at low levels, and added that, although this was considered to be mainly due to stable inflationary expectations, future developments in these rates and the effects on the world economy of low and stable long-term interest rates required close monitoring. A different member said that with ample liquidity in the market, some global investors were fairly optimistic about risks.

Some members said that it was worth noting that the year-on-year rate of decline in lending by private banks had been diminishing, albeit at a moderate pace. One member said that, as financial institutions were increasing their risk-taking capacity, they were making active efforts to find new lending opportunities particularly to small firms and real estate firms. A few other members noted the slight year-on-year increase in loans to real estate firms, and said that future developments in such loans and possible effects on the economy would require close monitoring.

One member raised developments in the money stock as a point for discussion in relation to developments in financial institutions' lending. This member commented that, for the growth rate of the money stock to increase, it was essential that financial institutions' lending increase when economic activity became more active and demand for funds increased, and that therefore the member would pay attention to future developments in lending. This member added that in assessing developments in the money stock, it was necessary to examine a wide range of indicators together, including broadly-defined liquidity. This was because a shift of funds from deposits to other assets with higher rates of return might occur as the financial situation stabilized.

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.

Members said that the Bank might face greater difficulty in supplying the amount of funds it intended to the market, because a substantial shortage of funds in current accounts at the Bank was projected through the beginning of March, in a situation where market participants were feeling even more strongly that there was an abundance of liquidity, due mainly to the further decrease in anxieties about the financial system. However, they agreed that it would be appropriate and seemed feasible to maintain the outstanding balance of current accounts at the Bank within the current target range by devising ways to enhance its conduct of money market operations.

On this basis, some members said that the possibility could not be ruled out that the outstanding balance of current accounts at the Bank might fall slightly below 30 trillion yen if there were unexpectedly large changes in demand for funds, and in such an event the Bank should bring it back in line as swiftly as possible. These members then expressed the view that this could be considered as being in line with the Bank's current guideline for money market operations, given that the guideline gave some margin above and below the target range as it was indicated as "at around" 30 to 35 trillion yen.

Many members explained their thinking with regard to the Bank's conduct of money market operations in the future.

One member expressed the view that, considering the process so far of raising the target range for the outstanding balance of current accounts at the Bank to ensure the stability of the financial markets, it would be appropriate to carefully lower the target range, with close monitoring of market conditions and other developments, when the stability of the financial system was confirmed after the upcoming full removal of blanket deposit insurance. This member, however, added that the Bank should firmly maintain the current quantitative easing policy framework until the three conditions in the Bank's commitment to continue the policy were fulfilled.

In response to this, one member said that there would be hardly any positive effects of lowering the target range compared with the negative effects. A different member said that lowering the target range should be considered as a technical issue rather than a policy matter.

Some members expressed the view that, since various uncertainties lay ahead, what could be said at this point was that it would be appropriate that, with regard to lowering the target range, the Bank carefully consider the following points. The Bank should accurately assess the economic and price situation and then thoroughly assess financial market conditions as well as the results of financial institutions' bidding in the Bank's operations. It should also consider the attitude of market participants and the public toward lowering the target range and possible effects, for example, on the Bank's future conduct of monetary policy.

IV. Remarks by Government Representatives

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

(1) Although Japan's economy was continuing to recover on the whole, supported mainly by domestic private demand, there were some movements that could be seen as minor adjustments in its ongoing recovery. Meanwhile, deflation persisted. This view of the present situation was supported by the first preliminary estimate of GDP released on February 16, 2005, which showed that real GDP for the October-December quarter of 2004 had decreased by 0.1 percent from the previous quarter.
(2) Under these circumstances, the government considered that ensuring the sustainability of the economic recovery led by private demand and overcoming deflation were the important tasks to be tackled through its policy efforts together with the Bank, and that the utmost efforts to achieve these aims continued to be necessary.
(3) The government recognized that based on this view the Bank had introduced the quantitative easing policy in March 2001, and it had been raising the target for the outstanding balance of current accounts at the Bank in stages, maintaining the outstanding balance of current accounts in line with the target, and indicating its policy stance to the public.
(4) The utmost efforts to achieve sustainable economic recovery led by the private sector and overcome deflation were still required. The government would therefore like the Bank to maintain the current policy and show the firmness of its stance to market participants and the public very clearly.

The representative from the Cabinet Office made the following remarks.

(1) The current economic situation was basically in line with the government's assessment that Japan's economy was continuing to recover on the whole, while some weak movements continued to be seen.
(2) The government expected that through its policy efforts together with the Bank the economy would make progress toward overcoming deflation in fiscal 2005. The government would accelerate and expand structural reforms in each sector, in order to realize an economic growth path with a nominal growth rate of around 2 percent or higher in and after fiscal 2006.
(3) The government would like the Bank to continue with its decisive monetary easing in order to ensure that deflation was overcome, communicating closely with the government. In overcoming deflation, it was essential that the money stock increase in the end, and given that changes in the outstanding balance of current accounts at the Bank had been attracting attention recently, the government would like the Bank to implement more effective monetary policy through effective provision of liquidity. The government would also like the Bank to clearly present a path toward overcoming deflation, as part of further efforts to enhance the transparency of the conduct of monetary policy.

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).

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, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, Mr. T. Fukuma, and Mr. A. Mizuno.
Votes against the proposal: None.

VI. Discussion on the Bank's View of Recent Economic and Financial Developments

Members discussed "The Bank's View" in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background"), and put it to the vote.

The Policy Board decided, by unanimous vote, the text of "The Bank's View." It was confirmed that "The Bank's View" would be published on February 17, 2005 and the whole report on February 18, 2005.⁶

6The English version of the whole report was published on February 21, 2005.

VII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of January 18 and 19, 2005 for release on February 22, 2005.

Attachment
February 17, 2005
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: