Minutes of the Monetary Policy Meeting

on November 17 and 18, 2005
(English translation prepared by the Bank's staff based on the Japanese original)

December 21, 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 Thursday, November 17, 2005, from 2:00 p.m. to 3:40 p.m., and on Friday, November 18, from 9:00 a.m. to 12:41 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. K. Akaba, Senior Vice Minister of Finance, Ministry of Finance²
Mr. K. Sugimoto, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. Y. Nakajo, Vice Minister for Policy Coordination, Cabinet Office

Reporting Staff 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. N. Takeda, Senior Economist, Monetary Affairs Department

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on December 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. K. Akaba was present on November 18.
Mr. K. Sugimoto was present on November 17.

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 October 31, 2005.⁵ The outstanding balance of current accounts at the Bank moved in the 31-35 trillion yen range. Responses of financial institutions to the Bank's funds-supplying operations had been generally favorable, but undersubscription had been observed recently.

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. 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. As for interest rates on term instruments, both three-month Euro-yen rates and yields on three-month treasury bills (TBs) and financing bills (FBs) were stable at low levels.

Japanese stock prices rose, reflecting a rebound in U.S. stock prices and announcements of strong business performance by many Japanese firms. The Nikkei 225 Stock Average returned to the 14,000-15,000 yen level for the first time since May 2001.

Long-term interest rates increased to around 1.6 percent, reflecting rises in U.S. long-term interest rates and Japanese stock prices, but weakened thereafter, moving at around 1.5 percent. This was mainly due to a slight decline in U.S. long-term interest rates and buybacks of Japanese government bonds (JGBs), mainly by foreign investors, in response to comments made by government officials.

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 being traded at around 119 yen to the dollar for the first time since August 2003. It depreciated against the currencies of most of Japan's major trading partners, and its nominal effective exchange rate declined substantially.

C. Overseas Economic and Financial Developments

The U.S. economy continued to expand steadily. Household spending and business fixed investment continued to increase. Prices had recorded a high increase temporarily due to the rise in energy prices, and in terms of the basic trend, the inflation rate was increasing moderately.

The euro area economy remained somewhat sluggish, although exports and production had picked up supported by depreciation of the euro.

With regard to 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 on the whole, although negative effects of high energy prices could be seen in, for example, household spending in some economies.

In U.S. and European financial markets, long-term interest rates had been on the rise, reflecting the persisting concern over inflation, but were declining somewhat recently due partly to a slight decrease in crude oil prices. Stock prices were rising. In financial markets in many emerging economies, 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

The first preliminary estimate of real GDP showed positive quarter-on-quarter growth for the fourth consecutive quarter in July-September. The figure was relatively strong, taking into account the high growth in the first half of 2005.

Exports continued to increase moderately against the background of the expansion of overseas economies. Exports to China, which had been somewhat lacking in momentum, and exports of IT-related goods showed clear signs of a pickup. 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. However, the GDP-based figure for business fixed investment for the July-September quarter seemed to be too high and thus might be revised downward in the second preliminary estimate.

Production had been on an uptrend with some fluctuations. Industrial production declined marginally in the July-September quarter on a quarter-on-quarter basis as in the April-June quarter, but this was mainly due to statistical fluctuations in steel ships and drugs. Production was expected to continue its uptrend, as overseas economies would continue to grow and the recovery in domestic demand was solid.

Although inventories remained low from a long-term perspective, they had recently increased somewhat in some industries, particularly in materials industries. However, among materials, high-value-added products for IT-related goods and automobiles remained in a favorable supply-demand condition. Adjustment pressure on inventories, therefore, was not considered to be particularly strong.

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. It 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. Although, as a reaction to high growth in the first half of 2005, consumption of goods was lackluster, services consumption continued to be steady. On a GDP basis, private consumption continued to increase in the July-September quarter following the increase in the previous quarter. Indicators for consumer confidence continued to be favorable on the whole. Private consumption was likely to continue recovering steadily against the background of a gradual increase in household income.

Domestic corporate goods prices had continued to increase, mainly reflecting the rise in international commodity prices and the depreciation of the yen. They were expected to continue increasing for the time being. 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 had become higher than the previous year's level.

The issuing environment for CP and corporate bonds was 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 was around 3.0 percent, and that of the money stock (M2+CDs) had been around 2.0 percent.

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 steadily with an increase in both domestic and external demand, although the pace of recovery had not accelerated since its emergence from the temporary pause.

Members agreed that overseas economies, particularly those of the United States and East Asia, continued to expand, and were likely to keep expanding at a pace around their potential growth rates.

On the U.S. economy, members concurred that household spending and business fixed investment continued to increase steadily, and in this situation production was on a moderate increasing trend and the employment situation had been improving. Many members said that judging from the latest available economic indicators, the effects of the hurricanes on the economy had not been as significant as initially thought. Some members, however, expressed the view that consumer confidence had deteriorated, mainly due to the effects of the hurricanes and of persistently high prices of petroleum products, and private consumption might slow temporarily. In response to this, a few other members commented that retail sales, except auto sales, had remained steady, and the risk of deceleration in private consumption was not significant. These members agreed that, in either case, attention should be paid to developments in Christmas sales. A few members said that some anecdotal information suggested a slowdown in the pace of increase in housing prices in urban areas, and that housing prices overall were starting to make a soft landing. Regarding U.S. stock prices, a few members pointed out that they were recovering, reflecting the market's positive reaction to the fact that the rise in crude oil prices had come to a halt. Some members said that since future developments in prices remained highly uncertain, attention should continue to be paid to the possibility of a change in the accommodative U.S. financial conditions triggered by a rise in concern about inflation.

With regard to East Asian economies, members agreed that both domestic and external demand continued to expand strongly in China, and the NIEs and ASEAN economies continued to recover led by the increase in exports. One member said that the expansion in production capacity in China over the course of fiscal 2006 might have a negative impact on supply and demand conditions in global materials markets. Some members expressed the view that anxiety over the spread of avian flu was growing in some East Asian economies, and if human infection with avian flu became widespread, their economies might be seriously affected.

Regarding Japan's economy, members agreed that exports continued to increase moderately and were likely 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 had continued to increase and was likely to keep increasing, since domestic and external demand was expected to continue increasing and corporate profits were likely to remain high. A few members said that according to the revised figure for business fixed investment plans for fiscal 2005 in the Survey of Capital Investment by Small Sized Manufacturers conducted by the Japan Finance Corporation for Small and Medium Enterprise, their business fixed investment for fiscal 2005 would increase for the third consecutive year, and this confirmed that the increase in business fixed investment was spreading to a wide range of firms. As for the outlook, many members expressed the view that, while firms had been absorbing the effects of the rise in crude oil prices, their interim results suggested that corporate profits remained strong, and therefore momentum in business fixed investment was very likely to be sustainable. One member said that firms might become more inclined to make business fixed investment in production facilities in Japan rather than overseas against the background of the continuing depreciation of the yen.

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. Many members expressed the view that the household sector would enjoy the effects of positive developments in the corporate sector not only through winter bonus payments, which were expected to be higher than last year's, but also through other channels besides earned income, such as a rise in stock prices and an increase in dividends. Members agreed that private consumption had been basically steady, given that services consumption had been generally steady and consumer confidence remained at high levels, although consumption of goods was lackluster in the July-September quarter as a reaction to high growth in the first half of 2005. Some members pointed out that sales of automobiles had recently been relatively sluggish, but this was partly attributable to the fact that no major new models had been introduced. Members concurred that private consumption was likely to continue to recover steadily against the background of a gradual increase in household income. A few members said that if consumers were shifting up their expectations for inflation to some extent, as suggested by the Consumer Confidence Survey, private consumption might increase more than expected as a result of an easing of consumers' stance of postponing purchases of durable goods in anticipation of a fall in prices. A few members said that housing investment had recently shown some strength partly because the decline in land prices was coming to a halt.

Members agreed that production had basically continued on a moderate increasing trend, and would continue its uptrend. Some members commented that, although it was expected that production would increase in the October-December quarter, there were uncertainties, such as future developments in adjustments in inventories of materials and U.S. Christmas sales, and therefore close monitoring would be needed.

Based on these discussions, members agreed that, as exports continued to increase and domestic demand was steady, Japan's economy was likely to experience a relatively long period of growth, albeit at a moderate pace. They also concurred that attention should continue to be paid to risk factors such as developments in crude oil prices and their effects on economic activity and prices, since the pace of recovery was only moderate.

On prices, members agreed that domestic corporate goods prices had continued to increase, mainly reflecting the rise in international commodity prices and the depreciation of the yen, and were expected to continue increasing. They also concurred that although consumer prices (excluding fresh food, on a nationwide basis) had currently 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 in line with economic recovery. Referring to the fact that crude oil prices were declining somewhat and some electric power companies had announced a reduction in electricity charges from April 2006, members discussed the outlook for prices presented in the Outlook for Economic Activity and Prices (hereafter the Outlook Report) released in October 2005. With regard to the recent decline in crude oil prices, one member commented that the Bank should carefully examine whether it reflected changes in their trend. Many members said that it was unnecessary for the Bank to change its assessment that the year-on-year rate of change in the consumer price index (CPI) was likely to rise above zero percent and remain positive, given that, since the release of the October Outlook Report, the yen had been depreciating, the output gap had improved, and the pace of decline in unit labor costs had been slowing. A few members said that if the potential growth rate had become higher than the Bank's assumed rate of approximately 1 percent presented in the Outlook Report, this might affect the Bank's outlook for prices through developments in the output gap and unit labor costs. Members agreed that it was important to take into account characteristics of each price indicator in order to appropriately assess price developments.

B. Financial Developments

On the financial front, members concurred that the financial environment remained extremely accommodative. With regard to the year-on-year change in lending by private banks (after adjustment for special items), which had recently been positive, members concurred that this reflected the fact that their lending attitude was becoming more accommodative and the pace of decline in credit demand in the private sector had been moderate. A few members said that the behavior of financial institutions, including how private banks' lending developed, should be watched carefully. One of these members commented that not only developments in lending but also a change in the overall flow of money should be monitored, as households were diversifying their financial assets from safe assets, particularly deposits, to riskier ones.

With regard to financial market developments since the release of the October Outlook Report, members agreed that they had been generally calm. Noting the rise in stock prices and the depreciation of the yen against the currencies of Japan's major trading partners, many members expressed the view that market participants generally agreed that Japan's economic activity was steady and were becoming more aware of wider interest rate differentials between Japan and overseas economies. One member commented that the yen might start to appreciate if, for example, it became the prevalent view that rises in U.S. interest rates would come to a halt in the near future. Another member expressed the view that the rise in stock prices had caused changes, through a lower earnings-price ratio, in the yield spread (government bond yield minus earnings-price ratio), which had been significantly below zero percent, and this might suggest a decline in investors' perception of risks involved in holding stocks. Some members said that the rise in stock prices and the depreciation of the yen might have been partly promoted by the decline in real interest rates, which reflected the improved outlook for prices, and the financial environment might be becoming more accommodative recently.

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

On the monetary policy stance for the immediate future, members agreed that it was appropriate to maintain the current framework of the quantitative easing policy in accordance with 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, 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 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. One member expressed the view that, although undersubscription had begun to be observed again in funds-supplying operations, the Bank could for the time being maintain the outstanding balance of current accounts within the target range without impairing the functioning of the market by taking various measures to improve money market operations.

Members discussed matters relating to communication concerning the future conduct of monetary policy. They agreed that, due to the appropriate explanation in the October Outlook Report, there was fairly wide acceptance, at least among market participants, of the Bank's view, which was as follows. First, it was becoming more likely that the economic recovery would be sustainable. Second, the year-on-year rate of change in consumer prices (excluding fresh food, on a nationwide basis) was projected to be 0.0 percent or a slight increase toward the end of the year, and it was expected to basically remain positive thereafter. And third, under these circumstances, the possibility of a departure from the present monetary policy framework was likely to increase over the course of fiscal 2006.

Some members, however, said that the Bank's thinking concerning a change of the policy framework and the conduct of monetary policy after the change might not have been fully understood by the public, especially non-market participants. These members said that, in order to enhance the understanding of a wider range of people concerning the meaning of a change of the policy framework and other matters explained in the October Outlook Report, the Bank should continue to explain clearly the following points among others. First, a change of the policy framework itself did not imply an abrupt change in terms of the effects of policy, and the accommodative financial environment was likely to be maintained even after the change of the policy framework if upward pressure on prices was contained and Japan's economy followed a sustainable and balanced growth path. And second, there would be in any case no change in the Bank's stance of striving to achieve sustainable growth with price stability.

A few members expressed the view that it was worth considering indicating a desirable rate of inflation that the Bank should pursue in the conduct of monetary policy, from the viewpoint of providing an anchor for economic agents' expectations regarding future developments in economic activity and prices and communicating the Bank's policy intention more clearly. Against this view, some members made the following points among others. First, a desirable rate of inflation was an objective for the medium to long term, and this must be fully understood by the public. Second, it was difficult to indicate a desirable rate of inflation for the medium to long term in the current situation where Japan's economy was still in the process of moving toward sustainable growth with price stability. And third, economic agents might have been making decisions based on the assumption that the rate of inflation would continue to be relatively low, since it had been continuously low in Japan. Members agreed that it was important for the Bank to keep an appropriate balance between enhancing the transparency of its conduct of monetary policy and securing flexibility and timeliness in its future policy conduct when communicating its thinking concerning it to the public.

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, as seen, for example, in the recently released first preliminary estimates of GDP statistics for the July-September quarter, which showed increases in private consumption and business fixed investment. In terms of the price situation, however, deflation persisted.
(2) Ensuring the sustainability of the economic recovery led by private demand and overcoming deflation were the most important policy tasks the government should tackle together with the Bank. To ensure the achievement of these policy tasks, the government would like the Bank to carry out in its conduct of monetary policy a careful and comprehensive assessment of economic activity and prices, including risk factors such as crude oil prices and the global economy, with close monitoring of developments in financial markets and overall interest rates.
(3) The government considered that, in the current economic situation where deflation persisted, steady and sustained policy efforts were necessary to overcome it. Therefore, the government would like the Bank to carefully explain to market participants and the public that it would firmly continue with the current quantitative easing policy.

The representative from the Cabinet Office made the following remarks.

(1) Japan's economy was recovering at a moderate pace. However, deflation persisted, as seen in the GDP deflator, which had declined for the 30th consecutive quarter, and overcoming deflation continued to be an important policy task the government should tackle together with the Bank.
(2) 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. As for the assessment of the current situation of and outlook for consumer prices, which were the basis for the necessary conditions for terminating the quantitative easing policy, 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.
(3) The government hoped that the Bank would implement effective monetary policy to overcome deflation in fiscal 2006 that would be consistent with the government's outlook for the economy. Furthermore, the government would like the Bank to consider presenting a desirable price level and the future path, including the Bank's thinking about the course in reaching that level, in order to promote proper formation of expectations in financial markets, and thereby contribute to sustainable economic growth with price stability and the overcoming of deflation.

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.

Two members, however, said that they 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."

As a result, the following proposal was submitted and put to the vote.

Mr. T. Fukuma and 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 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. 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.

The proposal was defeated by majority vote.

Votes for the proposal: Mr. T. Fukuma and 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, 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.

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. He said that, although he agreed with the Bank's basic thinking presented in the October Outlook Report concerning a change of the policy framework and the conduct of monetary policy after the change, 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, for the following three reasons. First, the Bank should encourage formation of interest rates based on the market mechanism as much as possible to restore the proper functioning of the market. 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, 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. Second, to minimize the possible shocks from the termination of the policy, the Bank should create an environment where it could communicate with market participants via interest rates. And third, delaying the lowering of the target range might increase the criticism that the Bank was responsible for accelerating the depreciation of the yen and causing global asset inflation.

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 November 18, 2005 and the whole report on November 21, 2005.⁶

6The English version of the whole report was published on November 22, 2005.

VII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of October 11 and 12, 2005 for release on November 24, 2005.

Attachment

November 18, 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: