Minutes of the Monetary Policy Meeting

on April 10 and 11, 2006

(English translation prepared by the Bank's staff based on the Japanese original)

May 24, 2006
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 Monday, April 10, 2006, from 2:00 p.m. to 3:47 p.m., and on Tuesday, April 11, from 8:59 a.m. to 12:43 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 PresentMr. 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. E. Hirano, Executive Director (Assistant Governor)
Mr. M. Shirakawa, Executive Director
Mr. A. Yamamoto, Executive Director
Mr. M. Amamiya, Director-General, Monetary Affairs Department
Mr. M. Ayuse, Deputy Director-General, Monetary Affairs Department⁴
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. 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. Y. Yamada, Director, Monetary Affairs Department⁴
Mr. K. Masaki, Senior Economist, Monetary Affairs Department
Mr. N. Takeda, Senior Economist, Monetary Affairs Department
Mr. T. Sakamoto, Director, Financial Markets Department⁴

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on May 18 and 19, 2006 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 April 11.
Mr. K. Sugimoto was present on April 10.
Messrs. M. Ayuse, Y. Yamada, and T. Sakamoto were present on April 11 from 8:59 a.m. to 9:16 a.m.

I. Summary of Staff Reports on Economic and Financial Developments⁵

A. Money Market Operations in the Intermeeting Period

The Bank conducted money market operations in accordance with the guideline decided at the previous meeting on March 8 and 9, 2006.⁶ The uncollateralized overnight call rate was stable at effectively zero percent throughout the intermeeting period, including the last business day of fiscal 2005. Meanwhile, the outstanding balance of current accounts at the Bank was at around 30 trillion yen in March, but decreased gradually from the beginning of April. It was slightly less than 26 trillion yen recently.

5Reports were made based on information available at the time of the meeting.
6The guideline was as follows:
The Bank of Japan will encourage the uncollateralized overnight call rate to remain at effectively zero percent.

B. Recent Developments in Financial Markets

Interest rates on term instruments, particularly the relatively longer-term rates, rose.

Japanese stock prices rose against the background of a further improvement in business sentiment, reflecting favorable economic indicators, and steady developments in overseas stock prices. The Nikkei 225 Stock Average was recently moving at around 17,500 yen.

Long-term interest rates rose against the background of firm Japanese stock prices, developments in overseas long-term interest rates such as those in the United States, and various views regarding the future conduct of monetary policy. They were moving in the range of 1.8-1.9 percent recently.

The yen fluctuated somewhat against the U.S. dollar, partly due to market participants' speculation about the future conduct of monetary policy in Japan and the United States. It was recently being traded in the range of 117-119 yen to 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.

In the euro area, although the economy remained somewhat sluggish, the momentum for recovery had been gradually increasing as evidenced by the recovery in exports and production partly due to the effects of the 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 some economic activity.

In U.S. and European financial markets, long-term interest rates rose partly against the background of growing market expectations of higher policy interest rates. Stock prices were more or less flat in the United States, while in Europe they rose. In financial markets in many emerging economies, although there were some constraints such as uncertainty regarding the future conduct of monetary policy by the Federal Reserve, the financial environment improved supported by firm economic fundamentals.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports had continued to increase against the background of the expansion of overseas economies. Exports to the United States had recently posted a sizeable gain, largely in exports of automobile-related goods. Exports to China had been increasing appreciably since the second half of 2005. Against the background of the further expansion of overseas economies, especially in the United States and East Asia, exports were expected to continue rising.

In the corporate sector, according to the March Tankan (Short-Term Economic Survey of Enterprises in Japan), corporate profits had been high and business sentiment had remained favorable. In this situation, business fixed investment had continued to increase and was expected to keep increasing because the expansion in domestic and external demand and the high level of corporate profits were likely to be maintained.

As for the employment and income situation in the household sector, household income had continued rising moderately, reflecting improvements in employment and wages, as various indicators for labor market conditions had been improving. The gradual increase in household income was likely to continue because firms were more aware of the shortage of labor and corporate profits were expected to remain high.

Private consumption had been on an increasing trend. The number of new passenger-car registrations had generally been picking up since the beginning of 2006, after showing weak developments in the second half of 2005. Sales of electrical appliances had continued their uptrend, although they had recently declined marginally as a reaction to the previous rise, and sales at department stores had remained firm. As for the outlook, private consumption was likely to continue increasing steadily, partly against the background of a gradual increase in household income.

Production had continued to increase on average against the background of the growth in domestic and external demand, although industrial production had decreased in February from the previous month. Production was expected to continue its uptrend, as overseas economies would continue to grow and the foundation for a recovery in domestic demand was solid. Inventories, taken as a whole, had been more or less in balance with shipments.

Domestic corporate goods prices had continued to increase, mainly reflecting the rise in international commodity prices. They were expected to continue increasing for the time being, mainly due to the effects of rising international commodity prices. The year-on-year rate of change in the consumer price index (CPI; excluding fresh food, on a nationwide basis) had been on a positive trend, recording 0.5 percent in February for the second consecutive month. As for the outlook, the year-on-year rate of change in the CPI was projected to continue to follow a positive trend, albeit with some fluctuations, as supply-demand conditions continued improving gradually.

2. Financial environment

The environment for corporate finance was accommodative. The issuing environment for CP and corporate bonds was favorable, and the lending attitude of private banks was becoming more accommodative. According to the March Tankan, the lending attitude of financial institutions as perceived by firms and the financial positions of firms had also been improving moderately. The decline in credit demand in the private sector was coming to a halt. Meanwhile, funding costs for firms had risen slightly.

The year-on-year growth rate of the money stock (M₂+CDs) had been at the 1.0-2.0 percent level.

II. Introduction of Funds-Supplying Operations against Pooled Collateral

A. Staff Proposal

With a view to facilitating money market operations by making bill purchasing operations paperless, the staff proposed that the Bank establish Principal Terms and Conditions for Funds-Supplying Operations against Pooled Collateral in order to introduce such operations.

B. Discussion by the Policy Board and Vote

Members voted unanimously to approve the proposal and agreed that the decision should be made public.

III. 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. Many members said that the economy was likely to continue to recover steadily as a virtuous cycle of production, income, and expenditure operated, reflecting the recovery in both domestic and external demand and also in the corporate and household sectors.

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

On the U.S. economy, many members expressed the view that, although there were signs of deceleration in housing sales, it continued to expand steadily, led mainly by household spending and business fixed investment, and was likely to keep expanding at a pace around its potential growth rate. Some members commented on price developments that, in a situation where the labor market continued to tighten and the capacity utilization rate remained high, attention should be paid to the risk of a heightening of inflationary pressure reflecting the rise in commodity prices including crude oil prices.

With regard to East Asian economies, members agreed that both domestic and external demand continued to expand strongly in China. One member noted that the U.S. trade deficit with China continued to expand and China's foreign exchange reserves continued to increase, and said that the future foreign exchange policy of the Chinese authorities warranted attention.

Some members commented on risk factors for the global economy that long-term interest rates were on a rising trend not only in the United States but globally, against the background of the rise in international commodity prices, particularly crude oil prices, and the concomitant heightening of inflation expectations.

Regarding Japan's economy, members agreed that exports had continued to increase, reflecting the expansion of overseas economies, and were likely to continue to rise.

As for domestic private demand, members concurred that business fixed investment had continued to increase against the background of the high level of corporate profits, and private consumption had been on an increasing trend as strong corporate performance was benefiting the household sector.

With regard to developments in the corporate sector, members agreed that business fixed investment had continued to increase, and was likely to keep increasing because the perception among firms of having excess production capacity had dissipated and corporate profits remained high. A few members said that, according to the March Tankan, business fixed investment plans for fiscal 2006 were at around or slightly above the level of those at the same time in the previous fiscal year regardless of industry or size of firm, and expressed the view that business fixed investment was likely to continue increasing steadily. Some members commented that the rate of increase in business fixed investment was still somewhat modest relative to the high level of corporate profits and of cash flow, and firms were basically maintaining their cautious investment stance. They continued that this cautious business stance of firms would support sustainable economic growth by preventing an excessive buildup of capital stock. One member said that, in a situation where the extremely accommodative financial environment continued, business fixed investment by small nonmanufacturers, which were sensitive to interest rates, warranted attention.

Members agreed that production had continued to increase on average, although it had decreased in February from the previous month, and that it was likely to increase further against the background of the growth in domestic and external demand.

Some members said that, although demand for IT-related goods was expected to continue increasing, developments in the inventory cycle suggested that slight adjustments in production and inventories might be made. From this viewpoint, one of these members added that particular attention should be paid to the balance between shipments and inventories of electronic parts and devices.

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, in a situation where labor market conditions had continued to improve and firms were more aware of the shortage of labor. On this point, one member said that it was noteworthy that large firms with favorable corporate performance in particular, such as automobile manufacturers, had agreed to a raise for the first time in several years in the wage negotiations between labor and management in spring 2006.

Members concurred that private consumption had been on an increasing trend, and was likely to continue to recover steadily, partly against the background of a gradual increase in household income. A few members noted that the diffusion index for business conditions in industries related to private consumption such as retailing and also restaurants and accommodations in the March Tankan was favorable, suggesting firmness in private consumption. One member said that sales of luxury goods had been favorable, and this might have been due to the rise in stock prices and the increase in dividends. A different member expressed the view, however, that the recovery in private consumption was firm but not very strong, given that there was a polarization of sales toward expensive goods and low-priced goods and that the recovery in outlays for services was limited to certain industries.

Many members expressed their views on the output gap and the potential growth rate of Japan's economy. Some members said that the output gap seemed to have closed, noting that, according to the March Tankan, the perception among firms of having excess production capacity had dissipated for the first time since the bursting of the bubble and firms were more aware of the shortage of labor. One member said that the past trend of total factor productivity and utilization rates of production capacity and labor was generally used in estimating potential output. However, given the recent changes in the economic structure, there was a risk of underestimating potential output with a past trend that included the period from the 1990s when the economy was sluggish. On this point, a few members said that implications for the outlook for economic activity and prices and the future conduct of monetary policy would differ depending on the view taken regarding the potential growth rate and its background.

Based on these discussions, members concurred that it was necessary to have in-depth discussions about the output gap and the potential growth rate in view of the upcoming Outlook for Economic Activity and Prices (hereafter the Outlook Report).

With regard to prices, members agreed that domestic corporate goods prices had continued to increase, mainly reflecting the rise in international commodity prices, and said that they were expected to continue increasing.

Many members noted that the year-on-year rate of change in the CPI (excluding fresh food, on a nationwide basis) in February had registered 0.5 percent for the second consecutive month, and that the year-on-year rate of change in the CPI, excluding special factors such as petroleum product prices and electricity and telephone charges, had also continued to be positive. One member pointed out that the uptrend in imputed rent, which had recently been contributing greatly to the increase in the CPI year on year, was likely to continue, and said that prices were clearly on an improving trend.

With regard to the outlook for the year-on-year rate of change in the CPI, members agreed that it was likely to continue to follow a positive trend, albeit with some fluctuations, based on the following points. First, the output gap was likely to continue narrowing gradually against the background of the continuing steady recovery in the economy. And second, downward pressures from unit labor costs were likely to weaken with the rise in wages. Some members commented on price developments for the immediate future that the effects of the revision of services prices made at the turn of the fiscal year should be closely monitored. One member said that, according to the March Tankan, the diffusion index for firms' perception of changes in output prices was improving, particularly among nonmanufacturers and small firms, and expressed the view that firms were starting to pass on higher costs in sales prices. Against this view, one member said that it should be borne in mind that manufacturers continued to have difficulty in passing on higher costs as international price competition was intensifying.

Regarding published land prices data, a few members said that, in the three major metropolitan areas (Tokyo, Osaka, and Nagoya), commercial land prices had increased for the first time in 15 years and the rate of decline in residential land prices had diminished markedly, while land prices in nonmetropolitan areas remained on a downward trend. On this basis, they expressed the view that, although large increases in land prices had been observed in some parts of central Tokyo, taken as a whole the formation of land prices was generally consistent with the expected return.

B. Financial Developments

On the financial front, members concurred that the financial environment remained extremely accommodative.

A few members pointed out that U.S. long-term interest rates had risen against the background of the following factors: the growing uncertainty about the future conduct of monetary policy in a situation where the policy interest rate seemed to be approaching a neutral level; and persisting concerns about inflation.

Some members commented on the fact that Japanese long-term interest rates had been rising and their volatility had increased somewhat since the previous meeting. They expressed the view that this was due not only to domestic factors such as firm Japanese stock prices reflecting a further improvement in business sentiment and various views regarding the future conduct of monetary policy, but also to the rise in long-term interest rates overseas, for example, in the United States. A few of these members noted that interest rates on instruments with medium-term maturities were rising noticeably and said that this to some extent reflected market participants' speculation about the future conduct of monetary policy.

Some members pointed out that, according to the March Tankan, the financial positions of firms and the lending attitude of financial institutions as perceived by firms had continued to improve both at large and small firms, and expressed the view that the environment for corporate finance had remained accommodative as before the termination of the quantitative easing policy. One member said that the Bank should examine carefully the financial environment including developments in funding costs for firms such as lending rates and issuance rates of CP and corporate bonds, in addition to developments in availability and volume of funds.

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

On the monetary policy stance for the immediate future, members agreed that, based on their assessment of the economic and financial situation, it was appropriate to maintain the current guideline for money market operations that the Bank would encourage the uncollateralized overnight call rate to remain at effectively zero percent.

Members concurred that developments in the money market since the termination of the quantitative easing policy, including the last business day of fiscal 2005, had been stable. They agreed that the Bank would continue to closely monitor conditions in the money market in reducing the outstanding balance of current accounts at the Bank. One member expressed the view that the pace of reduction would depend on conditions in the money market in the immediate future, and if the money market continued to be stable, it was likely that the reduction of the current account balance toward a level in line with required reserves would be realized over a period of a few months as planned. A different member said that there had been growing speculation among market participants that the zero interest rate policy would be terminated earlier than expected, and thus there was a risk that such speculation would increase further if the Bank reduced the current account balance too rapidly.

Members discussed the Bank's communication of its thinking concerning the conduct of monetary policy.

Members concurred that, taken as a whole, developments in financial markets since the termination of the quantitative easing policy had been stable, and understanding of the Bank's thinking concerning the conduct of monetary policy had been gradually spreading among market participants. Many members said that the Bank should further promote market participants' understanding of the new framework for the conduct of monetary policy.

Some members said that some market participants seemed to have misunderstood that the level of inflation referred to as "an understanding of medium- to long-term price stability" was directly related to the timing of a change in the Bank's monetary policy. These members said that the Bank should therefore promote market participants' understanding that the "understanding of medium- to long-term price stability" was the level of inflation each member currently understood as price stability which they would bear in mind in making decisions regarding the conduct of monetary policy and that it was not an inflation target or a numerical definition of price stability. On this point, a few members said that the Bank should explain that it was important to understand the three elements of the new framework for the conduct of monetary policy -- clarifying the Bank's thinking on price stability, examining economic activity and prices from the two perspectives, and outlining its current view on monetary policy -- as a whole. One member stressed that the "understanding of medium- to long-term price stability" could function as an anchor for price stability by ensuring both transparency and flexibility of monetary policy, and consequently, the Bank would be able to conduct monetary policy flexibly in the short term in response to developments in economic activity and prices.

One member said that, with regard to the Bank's thinking that the rate of inflation at which households and firms perceived price stability might be low because Japan's average rate of inflation had been lower in the past than that of major overseas economies, a criticism had been expressed that the Bank did not understand the forward-looking expectations formation mechanism. This member presented an empirical analysis which showed that in Japan perception of price stability was formed to a large extent in a backward-looking manner, based on past experience, and noted that pursuing an inflation rate that deviated from expectations formed in this way would carry a risk of causing a misunderstanding that the Bank was trying to induce higher inflation. The member continued that the backward-looking expectations could change over a relatively short period of time reflecting changes in the economic structure, and thus it was important to review the "understanding of medium- to long-term price stability" regularly.

Some members commented on a criticism that the new framework for the conduct of monetary policy lacked clarity compared with the Bank's commitment under the quantitative easing policy. They expressed the view that, under an interest rate policy, communication between market participants and the Bank should be changed from the one-way communication seen in the Bank's commitment under the quantitative easing policy to a dynamic two-way communication via market interest rates. On this point, one member said that the following interaction between the Bank and market participants would constitute the basis for communication under an interest rate policy. First, the Bank would present its basic thinking concerning the conduct of monetary policy and its assessment of economic activity and prices. Second, market participants would make transactions based on their views regarding interest rates, taking into account the Bank's basic thinking and its assessment. And third, the Bank would obtain important information on market participants' views from developments in financial markets.

With regard to the future path of monetary policy, members agreed that it was important to explain fully that, if it was judged that inflationary pressures were restrained as the economy followed a balanced and sustainable growth path, an accommodative monetary environment ensuing from very low interest rates would probably be maintained for some time, as indicated in the public statement released when the quantitative easing policy was terminated. On this point, some members said that the Bank should be careful in its communication, given that market participants were keenly interested in the future course of monetary policy.

V. Remarks by Government Representatives

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

(1) Japan's economy was recovering. A comprehensive review of developments in prices suggested that, although moderate deflation persisted, the price situation was improving gradually, as evidenced by, for example, the recently released year-on-year rate of change in the CPI (excluding fresh food, on a nationwide basis) for February recording 0.5 percent. The government considered that it was necessary to ensure that this improvement continued.
(2) The government would like the Bank to firmly support the economy from the financial side by maintaining a zero interest rate environment in order to ensure the overcoming of deflation and prevent the economy from weakening again, taking fully into account that ensuring the sustainability of the economic recovery and overcoming deflation were important policy tasks.
(3) The government would also like the Bank, as the central bank, to ensure market stability by carefully lowering the outstanding balance of current accounts at the Bank taking into account developments in the market and closely monitoring developments in overall interest rates including long-term interest rates.
(4) The government understood the Bank's unanimous decision regarding the Bank's view on monetary policy conduct at the previous Monetary Policy Meeting that, if it was judged that inflationary pressures were restrained, an accommodative monetary environment ensuing from very low interest rates would probably be maintained for some time. However, the message regarding the future path of monetary policy decided by the Bank seemed to have been misunderstood by some market participants, as could be seen in the fact that short- and medium-term interest rates had risen due to speculation that the Bank would begin a series of interest rates rises in the near future. The government would therefore like the Bank to ensure market stability by explaining its view on monetary policy conduct clearly to market participants and the public in line with the decision made at the previous Monetary Policy Meeting.

The representative from the Cabinet Office made the following remarks.

(1) Japan's economy was recovering. However, a comprehensive review of developments in prices suggested that moderate deflation persisted, although the price situation had been showing some improvement. It was therefore vital to achieve the government's goal of overcoming deflation in fiscal 2006, as it had reiterated in such Cabinet statements as "Basic Policies for Economic and Fiscal Management and Structural Reform," "Structural Reform and Medium-Term Economic and Fiscal Perspectives," and "Economic Outlook and Basic Stance for Economic and Fiscal Management."
(2) The Bank had been maintaining an accommodative financial environment by encouraging the uncollateralized overnight call rate to remain at effectively zero percent since the termination of the quantitative easing policy, taking consistency with the government's basic policy for the economy fully into consideration. The government would like to request that the Bank, in its future conduct of monetary policy, continue its policy efforts to overcome deflation together with the government and support the economy from the financial side responsibly.
(3) Given the Bank's new framework for the conduct of monetary policy introduced at the previous Monetary Policy Meeting, the government hoped that the Bank would explain more clearly its view on economic activity and prices and its outlook, as well as the relationship between these and the overcoming of deflation via, for example, the April Outlook Report, in order to make it easier for market participants and the public to form an economic outlook and stabilize their expectations.

VI. Votes

Based on the above discussions, members agreed that it was appropriate to maintain the current guideline for money market operations, which encouraged the uncollateralized overnight call rate to remain at effectively zero percent.

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 Money 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 encourage the uncollateralized overnight call rate to remain at effectively zero percent.

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

Votes against the proposal: None.

VII. 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 April 11, 2006 and the whole report on April 12, 2006.⁷

7The English version of the whole report was published on April 13, 2006.

VIII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of March 8 and 9, 2006 for release on April 14, 2006.

Attachment

April 11, 2006
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: