Minutes of the Monetary Policy Meeting

on July 27, 2005
(English translation prepared by the Bank's staff based on the Japanese original)

September 13, 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, July 27, 2005, from 9:00 a.m. to 11:33 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
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma
Mr. A. Mizuno
Mr. K. G. Nishimura

Government Representatives Present Mr. I. Ueda, Senior Vice Minister of Finance, Ministry of Finance
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. 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. Y. Nakayama, Director-General, Secretariat of the Policy Board
Mr. T. Kozu, Adviser to the Governor, Secretariat of the Policy Board
Mr. K. Murakami, Director, Secretariat of the Policy Board
Mr. K. Kamiyama, 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 September 7 and 8, 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.

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 July 12 and 13, 2005.³ The outstanding balance of current accounts at the Bank moved in the 30-34 trillion yen range. Meanwhile, undersubscription occurred repeatedly in the Bank's funds-supplying operations against the background of its provision of ample liquidity.

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. When it is judged that liquidity demand is exceptionally weak considering such factors as responses of financial institutions to the Bank's funds-supplying operations, there may be cases where the balance of current accounts falls short of the target.

B. Recent Developments in Financial Markets

The weighted average of the uncollateralized overnight call rate was at around zero percent. Interest rates on term instruments were stable at low levels.

Japanese stock prices were firm partly reflecting the rise in U.S. stock prices. Recently, the Nikkei 225 Stock Average was moving in the range of 11,500-12,000 yen.

Long-term interest rates rose slightly, partly reflecting a halt in the decline in long-term interest rates in the United States and Europe. Recently, they were moving in the range of 1.25-1.30 percent.

The yen depreciated slightly against the U.S. dollar, reflecting steady U.S. economic growth and the prospect of a wider interest rate differential between Japan and the United States. However, selling of the U.S. dollar against the yen increased in response to the revaluation of the renminbi, and the yen was recently being traded in the range of 111-113 yen against the dollar.

C. Overseas Economic and Financial Developments

The U.S. economy continued to expand at a pace around its potential growth rate. Household spending and business fixed investment had been increasing steadily, although the rate of growth declined slightly. The inflation rate had been rising at a moderate but steady pace.

In the euro area, production had been weak, and the economy overall had been sluggish.

With regard to East Asian economies, in China both domestic and external demand continued to expand strongly. The pace of increase in China's imports had decelerated significantly owing to such factors as inventory adjustments in some industries and a decline in the pace of increase in new investment due to the permeation of the government's measures to contain the overheating of the economy. Recently, however, China's imports showed signs of picking up. The People's Bank of China announced that it would reform the renminbi exchange rate regime, moving to a managed floating exchange rate regime in which the exchange rate would be set with reference to a basket of currencies, and would revalue the renminbi against the U.S. dollar by about 2 percent. The NIEs and ASEAN economies continued to expand at a moderate pace.

U.S. and European financial markets remained generally calm. U.S. long-term interest rates rose slightly amid speculation that the Chinese authorities' investment in U.S. Treasuries would decelerate following their reform of the exchange rate regime. Yield differentials between U.S. corporate bonds and U.S. Treasuries narrowed moderately.

In financial markets in emerging economies, many Asian currencies appreciated following the announcement of the reform of the renminbi exchange rate regime.

D. Economic and Financial Developments in Japan

Growth in real exports remained modest in the April-June quarter at 1.5 percent on a quarter-on-quarter basis. The pace of growth, however, increased somewhat compared to that in the previous two quarters. Growth in exports of automobiles to the United States increased significantly, while the momentum of growth in exports of IT-related goods to China remained weak.

The index of industrial production for May was revised downward from the preliminary figure. However, since the revision was due largely to the effects of special factors, production remained on a gradual uptrend.

Private consumption had been steady against the background of improvement in the employment and income situation. Sales of electrical appliances and sales at department stores continued their uptrend, and developments in sales during the summer bonus season seemed steady on the whole.

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 economic indicators released since the previous meeting confirmed that the economy continued to improve and was emerging from its temporary pause.

Members agreed that overseas economies, particularly those of the United States and East Asia, continued to expand, and were expected to keep expanding.

On the U.S. economy, some members said that both private consumption and business fixed investment continued to increase steadily. They expressed the view that the U.S. economy was likely to continue expanding at a pace around its potential growth rate. A few members noted that production in manufacturing, which had weakened somewhat, had recently showed signs of recovery. One member said that the effects on the U.S. economy and prices of developments in unit labor cost and energy prices, both of which were recently on an increasing trend, continued to require close monitoring. A different member expressed the view that the recent steady growth in private consumption was supported mainly by the wealth effect stemming from the rise in housing prices reflecting such factors as the low and stable long-term interest rates. Therefore, developments in private consumption required careful monitoring, given that rate increases by the Federal Reserve were expected to continue.

With regard to East Asian economies, many members commented that both domestic and external demand continued to expand strongly in China. As for China's imports, which remained relatively subdued, some members expressed the view that the main factors responsible were the effects of adjustment of the timing of contract and settlement ("leads and lags") for exports and imports as well as inventory adjustments and a decline in the pace of increase in new investment due to the government's measures to contain the overheating of the economy. One member noted that, in addition to these factors, a structural change in which imports were being replaced by domestically produced goods might be contributing to the situation.

Many members said that the reform in the exchange rate regime in China would enable the exchange rate of the renminbi to be determined more flexibly, and the Chinese economy was expected to achieve more balanced and sustainable growth in the long term as a result. Members agreed, however, that attention should be paid not only to the effects on the Chinese economy but also to the ripple effects on the world economy and international financial markets, since the effects in the short term would depend largely on how the managed floating exchange rate regime was actually operated.

Some members commented that the pace of growth in Japan's exports increased in the April-June quarter, albeit moderately, and it was expected to gradually accelerate as overseas economies continued to expand. One of these members added that the monthly change in the quantum index of exports had been positive for two consecutive months, and this was another sign that they were improving. One member said, however, that it was too early to judge that exports had regained momentum, although they showed some degree of improvement.

A few members said that in the corporate sector orders for machine tools were relatively strong, and the momentum of growth in business fixed investment was being maintained.

Some members expressed views concerning adjustments in IT-related sectors. They noted that adjustments in production and inventories of IT-related goods were progressing steadily, citing the fact that global demand for semiconductors was on a recovery trend and prices of dynamic random access memories (DRAMs) were bottoming out. They added, however, that the pace of adjustments in IT-related sectors in Japan was somewhat slower than in overseas economies, as seen in the fact that sales of semiconductor manufacturing equipment had been declining significantly in Japan. A different member expressed the opinion that it was difficult at this point to make a more positive assessment with regard to inventory adjustments in the IT-related sectors, as developments in inventories in China and some other factors were uncertain.

As for the situation in the household sector, some members said that summer bonus payments were likely to turn out to have been relatively good, and this supported the view that the income situation was tending to improve recently. One member commented that developments in sales during the summer bonus season seemed relatively steady, particularly those of summer clothes and of digital appliances and white goods.

On prices, members agreed that consumer prices would continue falling slightly on a year-on-year basis for the time being, but they might start rising at some point during late 2005 or early 2006, reflecting a falling off of the effects of special factors such as the reduction in electricity and telephone charges. One member said that the environment surrounding prices was changing, as seen in the narrowing of the output gap, high crude oil prices, and depreciation of the yen against the U.S. dollar. In this situation, particular attention should be paid to developments in unit labor cost, partly in order to judge whether upward pressure on prices continued to be to a large extent contained. A different member pointed out that the rise in crude oil prices was likely to exert further upward pressure on consumer prices in and after the fall of 2005, because it would be reflected in electricity charges, which were based on the fuel cost adjustment system.

B. Financial Developments

One member commented on reasons why U.S. long-term interest rates remained at low levels despite the expansion of the economy and a series of rate increases by the Federal Reserve, citing the following background factors. First, the rise in crude oil prices had reduced corporate profits and this had weakened expectations for economic growth. And second, at the same time enhanced transparency and public confidence in the conduct of monetary policy had contributed to stabilizing inflationary expectations and reducing uncertainty regarding future increases in short-term interest rates. A different member expressed the view that although U.S. long-term interest rates might rise at a moderate pace, the pace of increase was unlikely to accelerate due mainly to the following factors. First, the U.S. economy continued to grow at a sustainable pace while inflation was being contained, and the Federal Reserve intended to remove its policy accommodation at a measured pace in order to maintain such a situation. And second, there was a global glut of savings.

Some members commented on developments in financial and foreign exchange markets since the announcement of the reform of the renminbi exchange rate regime. They said that although the yen had appreciated somewhat against the U.S. dollar immediately after the announcement and U.S. long-term interest rates had risen slightly amid speculation that China's investment of foreign exchange reserves might be diversified, these markets remained generally calm. They added that many market participants seemed to be taking a wait-and-see stance on future developments related to the change in the exchange rate regime, such as how the managed floating exchange rate regime would be operated by the Chinese authorities.

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

On the monetary policy stance for the immediate future, members agreed that, in a situation where consumer prices had basically been declining slightly on a year-on-year basis, the Bank should continue to firmly maintain the current framework of the quantitative easing policy in accordance with the conditions in the Bank's commitment. One member stressed the importance of keeping the commitment, and expressed the opinion that the second condition regarding the forecasts for consumer prices was likely to be essentially satisfied when an autonomous recovery led by private demand was in prospect. In that situation, market participants would accept a somewhat flexible interpretation by the Bank of the condition.

A few members expressed the view that it would be appropriate to lower the target range for the outstanding balance of current accounts at the Bank, given that as concern about financial system stability was abating, liquidity demand among financial institutions was declining and they were feeling more strongly that there was an abundance of liquidity.

Against this view, the majority of members said that it was appropriate to maintain the current guideline for money market operations, including the proviso, given the assessment of economic activity and prices. Many members commented that in a situation where liquidity demand among financial institutions remained weak, the issuance of Japanese government securities, tax payments, and other factors would push down the current account balance at the Bank further from late July through the beginning of August. It was therefore becoming more likely that the outstanding balance of current accounts at the Bank would fall short of the target range during that period. These members continued that in conducting money market operations the Bank should do its utmost to provide funds while at the same time giving due consideration to the effects on the functioning of the market. Furthermore, if the outstanding balance fell short of the target range, the Bank should strive to make it return to the range as swiftly as possible. Some members said that the period in which the outstanding balance fell short of the target range might be somewhat longer than at the beginning of June 2005, but given that the balance was expected to return to the range around the middle of August at the latest due to payment of treasury funds and other factors, the Bank could respond to the situation by applying the proviso. One member expressed the view that maintaining the target range, thereby realizing an earlier overcoming of deflation, would be the quickest way of achieving the normalization of the Bank's monetary policy.

One member said that the expected fall in the outstanding balance of current accounts at the Bank would occur in a situation where the environment surrounding prices was changing. Therefore, the Bank should communicate its thinking with the greatest care in order to avoid misunderstanding that the fall was an indication of a change in the Bank's monetary policy stance. A different member expressed the opinion that the Bank should continue to ensure the public understood that applying the proviso was not a first step toward changing the framework of the quantitative easing policy, but was aimed at smoothly maintaining that framework.

Regarding policy responses to a possible further decline in liquidity demand among financial institutions, one member said that it could not be denied that a lowering of the target range for the outstanding balance of current accounts might become necessary. However, the Bank should carefully examine issues relating to lowering the target range based on the economic situation, since it could be interpreted as a tightening of monetary policy. A different member expressed the view that although it was appropriate to maintain the current target range for the time being, carefully lowering it, while ensuring understanding outside the Bank that this would not hinder the process of overcoming deflation, would be one of the options in the future.

IV. Remarks by Government Representatives

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

(1) Japan's economy was recovering at a moderate pace, while some signs were seen of coming out of a weak situation. However, deflation persisted. The effects on Japan's economy of developments in crude oil prices, which continued to rise substantially, continued to warrant attentive monitoring. In addition, the effects on Japan's economy of the reform of the renminbi exchange rate regime by the Chinese authorities should be watched closely.
(2) Under these circumstances, ensuring the sustainability of the economic recovery led by private demand and overcoming deflation were the most important policy tasks. The government would like the Bank to explain clearly that its stance of firmly maintaining the current quantitative easing policy in order to overcome deflation remained unchanged. With regard to the new sentence added to the proviso in the guideline for money market operations from a technical viewpoint, the government hoped that the Bank would continue to appropriately apply the new proviso in accordance with the reasons for which the Bank had amended it.

The representative from the Cabinet Office made the following remarks.

(1) Japan's economy was recovering at a moderate pace, while some signs were seen of coming out of a weak situation. However, on the financial front the year-on-year growth rate of the money stock (M2+CDs) remained at the 1.0-2.0 percent level, and taking into account the overall price situation, deflation persisted.
(2) The government, keeping in mind its expectation of a nominal economic growth rate of around 2 percent or higher in and after fiscal 2006, would accelerate and expand structural reforms focusing on expansion of private demand and employment and ensure that deflation was overcome, at the same time realizing both economic vitalization and budget consolidation.
(3) While the economy was recovering gradually, it was essential that the money stock increase in the end in overcoming deflation. The government therefore hoped that the Bank would implement effective monetary policy that would be consistent with the government's policy efforts to overcome deflation and with its outlook for the economy, while giving due consideration to market developments and expectations.

V. Votes

Based on the above discussions, the majority of members agreed that it was appropriate to maintain the current guideline, including the proviso, for money market operations with the target for the outstanding balance of current accounts at the Bank at around 30 to 35 trillion yen.

One member, however, said that the member would like to propose that the Bank should lower the target for the outstanding balance of current accounts at the Bank from "around 30 to 35 trillion yen" to "around 27 to 32 trillion yen." A different member said that the member would like to propose that the Bank should lower the target for the outstanding balance of current accounts at the Bank from "around 30 to 35 trillion yen" to "around 25 to 30 trillion yen."

As a result, the following proposals were submitted and put to the vote.

Mr. T. Fukuma proposed the following guideline for money market operations for the intermeeting period ahead:

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.

The proposal was defeated by majority vote.

Votes for the proposal: Mr. T. Fukuma.

Votes against the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, Mr. A. Mizuno, and Mr. K. G. Nishimura.

Mr. A. Mizuno proposed the following guideline for money market operations for the intermeeting period ahead:

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 25 to 30 trillion yen.

The proposal was defeated by majority vote.

Votes for the proposal: Mr. A. Mizuno.

Votes against the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, Mr. T. Fukuma, and Mr. K. G. Nishimura.

To reflect the majority view, the chairman formulated the following proposal.

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

The guideline for money market operations for 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. When it is judged that liquidity demand is exceptionally weak considering such factors as responses of financial institutions to the Bank's funds-supplying operations, there may be cases where the balance of current accounts falls short of the target.

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

Votes against the proposal: Mr. T. Fukuma and Mr. A. Mizuno.

Mr. T. Fukuma dissented from the above proposal for the following reasons. First, as financial institutions' demand for funds for current accounts at the Bank had been further declining recently, lowering the target range for the outstanding balance of current accounts at the Bank carefully to respond to the situation would contribute to smoother conduct of the quantitative easing policy. Second, there was a possibility that maintaining a huge outstanding balance of current accounts at the Bank would hinder the process of restoring the proper functioning of the market, and cause excessive risk taking based on unrealistic expectations that the current extremely accommodative conditions would continue for a very long time, which would in turn increase interest rate risk in the future. And third, it was possible to support the ongoing economic recovery, and thereby the overcoming of deflation, by maintaining the zero interest rate environment based on the Bank's commitment in terms of policy duration.

Mr. A. Mizuno dissented from the proposal for the following reasons. First, the decline in liquidity demand among financial institutions was becoming more conspicuous. Second, it was already fully understood in the markets that lowering the target range did not indicate a change in the current framework of the quantitative easing policy. And third, it would be appropriate to start lowering the outstanding balance of current accounts at the Bank at an early stage in response to the decline in liquidity demand among financial institutions in order to stabilize the formation of interest rates in the period around the termination of the quantitative easing policy.

Attachment
July 27, 2005
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by 7-2 majority vote, to set the following guideline for money market operations for the intermeeting period: