Minutes of the Monetary Policy Meeting

on October 11 and 12, 2005
(English translation prepared by the Bank's staff based on the Japanese original)

November 24, 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 Tuesday, October 11, 2005, from 2:00 p.m. to 3:52 p.m., and on Wednesday, October 12, from 9:00 a.m. to 12:17 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
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 Finance²
Mr. K. Sugimoto, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. J. Hamano, Director General for Economic and Fiscal Management, Cabinet Office³
Mr. J. Saito, Deputy Director General for Economic and Fiscal Management, Cabinet Office²

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. S. Shiratsuka, Senior Economist, Monetary Affairs Department
Mr. N. Takeda, Senior Economist, Monetary Affairs Department⁴

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on November 17 and 18, 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.
Messrs. I. Ueda and J. Saito were present on October 12.
Messrs. K. Sugimoto and J. Hamano were present on October 11.
Mr. N. Takeda was present on October 12.

I. Summary of Staff Reports on Economic and Financial Developments⁵

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on September 7 and 8, 2005.⁶ The outstanding balance of current accounts at the Bank moved in the 31-35 trillion yen range throughout the intermeeting period, including September 30, the day of semiannual book closings. Responses of financial institutions to the Bank's funds-supplying operations were favorable, and maturities of funds-supplying operations shortened somewhat.

5Reports were made based on information available at the time of the meeting.
6The 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 rose somewhat in response to an improved perception of the economy and market participants' view that the quantitative easing policy would be terminated earlier than previously expected.

Japanese stock prices rose, reflecting increased expectations of economic recovery. The Nikkei 225 Stock Average moved at around 13,500 yen for the first time since May 2001.

Long-term interest rates increased, reflecting an improved perception of the economy, and were moving at around 1.5 percent recently.

The yen depreciated against the U.S. dollar due to increased prospects of a wider interest rate differential between Japan and the United States, and was recently being traded in the range of 114-115 yen against the dollar.

C. Overseas Economic and Financial Developments

The U.S. economy continued to expand steadily, at a pace around its potential growth rate, led mainly by household spending and business fixed investment. The core inflation rate continued to be on a moderate but steady rising trend. The effects of the two hurricanes that had struck the country since late August started to appear in some indicators, such as those relating to household spending and consumer confidence.

The euro area economy was still sluggish, although exports and production were picking up partly due to depreciation of the euro.

With regard to East Asian economies, in China both domestic and external demand continued to expand strongly. The year-on-year rate of growth in China's imports had been picking up recently. The NIEs and ASEAN economies continued to expand at a moderate pace on the whole, although negative effects of high energy prices could be seen in some countries.

In U.S. and European financial markets, long-term interest rates rose, mainly reflecting an increase in concerns about inflation. Stock prices in the United States moved within a certain range, while those in Germany and the United Kingdom rose. In financial markets in many emerging economies, while their currencies depreciated in response to appreciation of the U.S. dollar, their stock prices rose and yield differentials between their sovereign bonds and U.S. Treasuries narrowed.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports continued to increase moderately against the background of the expansion of overseas economies. Exports to China, which had been somewhat lacking in momentum, showed clear signs of a pickup. Increases in exports of IT-related goods and motor vehicle parts were becoming noticeable. Exports were expected to continue rising against the background of the expansion of overseas economies.

In the corporate sector, business fixed investment had continued to increase against the background of high corporate profits and a modest improvement in business sentiment. According to the September Tankan (Short-Term Economic Survey of Enterprises in Japan), business fixed investment plans for fiscal 2005 of large firms both in manufacturing and nonmanufacturing were strong, and those of small firms were revised upward steadily across a wide range of industries.

Production had basically continued its moderate increasing trend. The monthly average of industrial production in the July-August period declined marginally compared to that of the April-June quarter. However, production in the July-September quarter as a whole was projected to rise, since the decline in the July-August period seemed to be mainly due to statistical fluctuations with regard to steel ships and drugs, and the forecast index for September displayed a substantial increase. As for the outlook, production was expected to continue its uptrend, as overseas economies would continue to grow and the recovery trend of domestic demand was firm.

Inventories had recently increased somewhat in some industries, particularly in the materials industries, although they remained low from a long-term perspective. Deterioration in the inventory level diffusion index in these industries in the September Tankan was marginal, and this suggested that inventory adjustments had been relatively small. Shipments of electronic parts and devices recovered in the July-August period, and this confirmed the completion of inventory adjustments in that sector.

As for the employment and income situation, household income had been rising moderately, reflecting improvements in employment and wages, as various indicators for labor market conditions had been improving. Regarding the outlook, household income was likely to continue increasing gradually, since the perception among firms of having excess labor had generally dissipated and corporate profits were likely to remain high.

Private consumption had been steady. Sales indicators such as sales at department stores had shown slight declines since July as a reaction, after having been relatively strong on the whole until June. However, indicators for consumer confidence continued to be favorable on the whole, and private consumption was likely to continue recovering steadily against the background of a gradual increase in household income.

Domestic corporate goods prices had increased, mainly reflecting the effects of the rise in crude oil prices. They were expected to continue increasing mainly due to high crude oil prices. Consumer prices (excluding fresh food, on a nationwide basis) had been declining slightly on a year-on-year basis. The year-on-year rate of change in consumer prices was projected to be 0.0 percent or a slight increase toward the end of the year. This was mainly because the effects of the decline in rice prices and the reduction in electricity and telephone charges were expected to ease in a situation where supply and demand conditions continued improving gradually.

2. Financial environment

The environment for corporate finance was becoming more accommodative on the whole. The lending attitude of private banks was becoming more accommodative, and that of financial institutions as perceived by firms had also been improving. Under these circumstances, lending by private banks was around the previous year's level.

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 had been above the previous year's level.

The year-on-year growth rate of the monetary base and that of the money stock (M2+CDs) were at the 1.0-2.0 percent level.

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 agreed that it continued to recover led mainly by steady domestic private demand, and this was expected to continue. They also concurred with the view that the economic recovery was likely to be sustainable, as adjustments in IT-related sectors had been completed and domestic private demand had been firm.

Members agreed that overseas economies, particularly those of the United States and East Asia, continued to expand, and were expected to continue expanding at a pace around their potential growth rates. Many members said, however, that close attention should be paid to an increase in uncertainty about the world economic outlook due to the effects of the hurricanes and the prolonged period of high crude oil prices.

On the U.S. economy, many members expressed the view that, although negative effects of the hurricanes had started to appear in some indicators as seen in a deterioration in consumer confidence, deceleration in economic activity was likely to be temporary largely because reconstruction-related demand was expected. Some members commented, however, that uncertainty about the economic outlook had been increasing, as the impact of the hurricanes on facilities for oil production and refineries was not insignificant and crude oil prices were likely to remain high. Some members noted that potential inflationary risks were beginning to be noticed, partly reflecting developments in unit labor costs, which had been posting an increase year on year. They continued that attention should be paid to whether a possible rise in long-term interest rates accompanying an increase in inflation expectations could cause adjustments in housing prices and a deterioration in household spending. One member said that the possible negative effects of a rise in long-term interest rates seemed to have been increasing, as households' financial liabilities had been expanding with a rise in real estate prices.

With regard to East Asian economies, many members expressed the view that both domestic and external demand continued to expand strongly in China. A few members said, however, that future developments in the Chinese economy should be watched closely, since there were structural factors that could destabilize the economy, such as imbalances among sectors and regions. One member pointed out that in many ASEAN economies exports had continued to increase, as adjustments in IT-related sectors had been completed.

Members agreed that Japan's exports continued to increase at a moderate pace, partly reflecting a clear pickup in exports to China, which had been somewhat lacking in momentum. Members also agreed that Japan's exports were expected to continue to rise, as overseas economies continued to expand.

Members concurred that domestic private demand continued to be firm.

With regard to developments in the corporate sector, members agreed that business fixed investment continued to increase, and was expected to continue increasing against the background of high corporate profits. Many members referred to survey results in the September Tankan, and said that corporate profits continued to show strong performance even though firms had been absorbing the effects of the rise in crude oil prices, and in this situation, business fixed investment was likely to continue to increase. A few members noted that the Tankan showed that even small firms' plans for business fixed investment had been revised upward, and this confirmed that the increase in business fixed investment was spreading to a wide range of firms.

Members concurred that positive developments in the corporate sector were spreading steadily to the household sector.

As for the employment and income situation, members agreed that the number of employees and wages had been increasing, and household income had continued to rise moderately on the whole. One member expressed the view that the rise in household income was likely to continue, as the diffusion index for employment conditions in the September Tankan showed that the number of firms perceiving their holdings of labor as insufficient had started to exceed the number perceiving them as excessive, regardless of the size of firms. Many members said that private consumption had been steady on the whole as seen in consumer confidence, which remained at high levels, although in some sales indicators for July and August a reaction following strong sales until June was observed. They added that private consumption was likely to continue to recover steadily against the background of a gradual increase in household income. One member commented that wealth effects were also contributing to the steady developments in private consumption.

Many members said that although the monthly average of industrial production in the July-August period declined marginally compared to that of the April-June quarter, production was basically on a moderate uptrend, the weakness being largely due to statistical fluctuations with regard to steel ships and drugs. Members agreed that shipments in IT-related sectors recovered in the July-August period, and completion of inventory adjustments in IT-related sectors was confirmed.

Based on these discussions, members agreed that, as exports continued to increase, Japan's economy would continue to experience a relatively long period of growth, albeit at a moderate pace, supported by steady domestic demand. However, since the pace of recovery was only moderate, attention should be paid to risk factors such as developments in crude oil prices, which remained high, and their effects on the world economy.

On prices, members agreed that domestic corporate goods prices had increased, mainly reflecting the surge in crude oil prices, and were expected to continue increasing. They also concurred that although consumer prices (excluding fresh food, on a nationwide basis) had recently been declining slightly on a year-on-year basis, the year-on-year rate of change in consumer prices was projected to be 0.0 percent or a slight increase toward the end of the year. This was because the effects of the decline in rice prices and the reduction in electricity and telephone charges were expected to ease, as supply and demand conditions continued to improve gradually in line with economic recovery.

One member expressed the view that if the judgment of whether the economy was in deflation was to be primarily based on the assessment of prices of goods and services consumed by households, the GDP deflator, which included other demand components such as private investment, government spending, and net exports, was not necessarily an appropriate indicator. The member continued that if the price situation was to be assessed based on GDP statistics, the deflator for consumption of households should be used. Nevertheless, it should be borne in mind that, even after the introduction of the chain-linking method, the deflator still had a downward bias as it was a Paasche index and so had a tendency to overstate a decline in prices of such products as personal computers. A different member commented that it was important to take into account the effects of the upward bias of the consumer price index (CPI) when assessing the price situation. Another member said that the term "deflation" was ambiguous and should therefore be used carefully.

Some members commented that in terms of the Prefectural Land Price Survey, land prices seemed to be bottoming out, given that there had been a distinct narrowing in the rate of decline in commercial and residential land prices in the three metropolitan areas (Tokyo, Osaka, and Nagoya) and that the rate of change in land prices of the 23 wards of Tokyo had become positive for the first time in 15 years.

B. Financial Developments

On the financial front, members concurred that the financial environment remained extremely accommodative. Regarding the fact that the year-on-year growth rate of the money stock had recently been at around 1.5-2.0 percent, some members noted the following points. First, firms' cash flow was abundant. Second, corporate financing means had further diversified. And third, "a shift of funds from saving to investment" had been observed. These members continued that in such a situation the relation between developments in the money stock and the growth rate of nominal GDP would remain unstable for some time and a relatively low growth rate of the money stock was consistent with sustainable economic recovery.

With regard to financial market developments, members concurred with the view that an improved perception of the economy was the main factor behind the substantial rise in stock prices and the slight increase in long-term interest rates. Some members said that the rise in stock prices was attributable to the active investment stance of foreign investors, who had responded favorably to the result of the general election and the positive view of the prospects for business performance. One member commented that developments in purchases of stock futures and sales of bond futures, mainly by foreign investors, should be monitored. A few members said that attention should be paid to margin transactions, which were increasing substantially as stock prices rose.

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 the CPI had been declining slightly on a year-on-year basis, it was appropriate to maintain the current framework of the quantitative easing policy in accordance with the conditions in the Bank's commitment.

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 at this point mainly for the following reasons. First, as concern about financial system stability was abating, financial institutions' demand for liquidity required for funds management was on a declining trend. And second, the Bank should encourage formation of interest rates based on the market mechanism as much as possible from an early stage to ensure smooth termination of the quantitative easing policy in the future.

Against this view, the majority of members said that it was appropriate to maintain the current guideline for money market operations, including the proviso. Some members expressed the view that maintaining the outstanding balance of current accounts within the target range without impairing the functioning of the market was feasible, as responses of financial institutions to the Bank's funds-supplying operations continued to be favorable and undersubscription had occurred less frequently. A few of these members said that it could not be denied that carefully lowering the target range might become necessary if liquidity demand among financial institutions declined further in the future. However, the Bank should carefully examine issues relating to lowering the target range based on the economic situation, considering how market participants would respond.

Members discussed appropriate ways of communication concerning the future conduct of monetary policy. They agreed that as a result of the Bank's communication recently, the view had become prevalent among market participants that the economic recovery was sustainable and the possibility of a departure from the quantitative easing policy was likely to increase over the course of fiscal 2006. Some members said that it was important for the Bank to explain more clearly that the effects of the quantitative easing policy were increasingly coinciding with the effects of short-term interest rates being at practically zero percent, and thus a change of the policy framework itself did not imply an abrupt change in terms of effects of policy.

As for the Bank's communication concerning its policy conduct after the termination of the quantitative easing policy, many members said that the Bank should keep an appropriate balance between ensuring smooth formation of expectations in financial markets and maintaining the flexibility of its conduct of monetary policy to respond to changes in the economic and financial situation. Members agreed that these points relating to the Bank's communication should be examined thoroughly in the process of preparing the Outlook for Economic Activity and Prices to be released at the end of October. A few members expressed the view that the Bank should communicate based on a consensus achieved through discussions at Monetary Policy Meetings.

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. However, deflation persisted as evidenced, for example, by the year-on-year rate of decline in the CPI and the GDP deflator. As crude oil prices remained at high levels, their effects on the domestic and overseas economies would require close monitoring.
(2) Ensuring the sustainability of the economic recovery led by private demand and overcoming deflation continued to be the most important policy tasks the government should tackle together with the Bank, and the utmost efforts to achieve these aims continued to be necessary. Therefore, the government would like the Bank to continue to examine economic activity and prices thoroughly, and explain carefully to the public and market participants that the Bank's stance of firmly maintaining the current quantitative easing policy remained unchanged in a situation where deflation persisted.

The representative from the Cabinet Office made the following remarks.

(1) Japan's economy was recovering at a moderate pace. However, deflation persisted and overcoming it continued to be the most important policy task the government should tackle.
(2) The year-on-year growth rate of the money stock (M2+CDs) was still only at the 1.0-2.0 percent level despite the economic recovery, and various factors had been pointed out as responsible for this. Recently, however, a recovery of the credit creating function of banks was in prospect, mainly because concern about financial system stability had disappeared and the year-on-year change in lending by private banks (after adjustment for special items) had finally turned positive.
(3) 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. In assessing the state of deflation, a comprehensive analysis of price developments based not only on consumer prices but also on the GDP deflator would be necessary. The government would like the Bank to give due consideration mainly to the following factors: the effects of the rise in crude oil prices in relation to the mechanism of price formation; other special factors; and statistical bias, and carefully assess the current situation of and outlook for consumer prices. The government hoped that the Bank would contribute to overcoming deflation by promoting proper formation of expectations in financial markets.

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, arguing that the Bank should lower the target range for the outstanding balance of current accounts at the Bank gradually in a step-by-step manner, while carefully examining economic and financial developments, as long as the maintenance of the current framework of the quantitative easing policy would not be hindered. Noting the current situation where market participants had factored in a scenario where the Bank would terminate the quantitative easing policy over the course of fiscal 2006, he gave the following three reasons. First, the Bank should encourage formation of interest rates based on the market mechanism as much as possible to promote communication with market participants. Second, the Bank should shorten maturities of funds-supplying operations to enhance the timeliness and flexibility of its conduct of monetary policy. And third, it was possible to support the ongoing economic recovery and thereby emergence from the situation of slight price declines 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, there had been no change from the downtrend in financial institutions' precautionary demand for liquidity, and thus lowering the outstanding balance of current accounts at the Bank as a response to this was reasonable policy conduct. Second, to ensure financial market stability in the period around the termination of the quantitative easing policy, it would be appropriate to start lowering the outstanding balance in line with developments in the market, rather than lowering it intensively over a short period of time after achieving the three conditions in the Bank's commitment to continue the policy. And third, delaying the lowering of the target range involved economic cost, for example, continuation of an abnormal situation where the massive outstanding balance of current accounts at the Bank had been restraining a rise in interest rates on term instruments and hindering interest rates from performing their function.

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 October 12, 2005 and the whole report on October 13, 2005.⁷

7The English version of the whole report was published on October 14, 2005.

VII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of September 7 and 8, 2005 for release on October 17, 2005.

Attachment

October 12, 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: