Minutes of the Monetary Policy Meeting

on April 28, 2006

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

June 20, 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 Friday, April 28, 2006, from 9:00 a.m. to 12:39 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 Finance
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. 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 Department²
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. K. Kamiyama, Senior Economist, Monetary Affairs Department

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on June 14 and 15, 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. Momma was present from 9:50 a.m. to 12:39 p.m.

I. Summary of Staff Reports on Economic and Financial Developments³

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 April 10 and 11, 2006.⁴ The uncollateralized overnight call rate was stable at effectively zero percent. The outstanding balance of current accounts at the Bank decreased gradually, and was at around 20 trillion yen recently.

3Reports were made based on information available at the time of the meeting.
4The 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

In the money market, interest rates on term instruments had stopped rising and had been more or less flat. Long-term interest rates were moving at around 1.9 percent recently. Japanese stock prices declined, partly reflecting an appreciation of the yen against the U.S. dollar, in a situation where market concern about the high level of stock prices was increasing. The Nikkei 225 Stock Average was recently moving at around 17,000 yen. The yen had appreciated against the U.S. dollar, and was being traded in the range of 114-115 yen recently.

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 business fixed investment and private consumption, although housing investment was decelerating gradually. 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. 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 reflecting speculation about the Federal Reserve's monetary policy for the near future. Stock prices in the United States and Europe rose, partly due to some firms' favorable earnings reports. With regard to financial markets in many emerging economies, the financial environment improved supported mainly by firm economic fundamentals.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports had continued to increase at a relatively high pace since the second half of 2005 against the background of the expansion of overseas economies. They recorded 3.4 percent quarter-on-quarter growth in the January-March quarter of 2006.

The Annual Survey of Corporate Behavior (Fiscal 2005) conducted by the Cabinet Office showed that firms expected real economic growth to be close to 2 percent, and it also suggested that their attitude toward business fixed investment and employment was positive. According to the survey conducted by the Japan Finance Corporation for Small and Medium Enterprise in March, the proportion of small firms that had carried out business fixed investment was at a high level for both manufacturers and nonmanufacturers.

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. Private consumption remained on an increasing trend on average, although some indicators, including sales at department stores and at supermarkets, dropped back in the January-March quarter, after having posted strong sales in the previous quarter.

Industrial production increased only modestly in the January-March quarter, recording 0.6 percent quarter-on-quarter growth. It was, however, expected to show steady growth in the April-June quarter. 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 prices of international commodities, such as crude oil and nonferrous metals. 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 March. 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. The preliminary figure for the year-on-year rate of change in consumer prices (excluding fresh food) in the Tokyo metropolitan area increased slightly to 0.3 percent in April, led by services prices.

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. 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.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. A few members expressed the view that economic activity in fiscal 2005 seemed to have been stronger than the projection in the October 2005 Outlook for Economic Activity and Prices (hereafter the Outlook Report).

Members agreed that overseas economies, particularly those of the United States and East Asia, continued to expand. A few members noted that projections for world economic growth by, for example, international organizations had been revised upward. On the U.S. economy, some members pointed out that some indicators, such as retail sales and the consumer confidence index, were stronger than expected, although housing investment was decelerating gradually. Some members said that, although the Chinese economy continued its high growth, it should be watched for signs of overheating. Many members commented that as prices of international commodities, such as crude oil and nonferrous metals, remained at high levels, attention should continue to be paid to developments in these prices and to their effects on financial markets and economic activity.

Members concurred that Japan's exports had continued to increase against the background of these developments in overseas economies.

With regard to developments in the corporate sector, a few members pointed out that firms remained cautious about future developments in demand, according to the Annual Survey of Corporate Behavior (Fiscal 2005) conducted by the Cabinet Office. A few members said that some firms had been unable to pass on higher production costs resulting from the rise in crude oil prices, and attention should be paid to the effects on corporate profits. One member commented that although it was true that corporate profits had been strong, it should be noted that the figures included profits from overseas business operations. The member continued that firms were relatively active in making business fixed investment abroad, but they had been cautious at home.

As for the household sector, many members expressed the view that private consumption remained steady in a situation where labor market conditions had continued to improve. One member pointed out that, although private consumption was on an increasing trend, related indicators for the January-March quarter were somewhat sluggish, and this might be partly in reaction to the strong previous quarter.

Most members agreed that domestic corporate goods prices had continued to increase due mainly to the effects of the rise in prices of commodities, in particular crude oil, at home and abroad. Many members commented that a positive trend in consumer prices was becoming clear, as evidenced by the fact that the preliminary figure for the year-on-year rate of change in consumer prices in the Tokyo metropolitan area rose slightly in April led by revisions of services prices, such as education expenses, at the beginning of the new fiscal year.

A few members said that it was confirmed in the Regional Economic Report, which was released in the middle of April, that the economy remained on a recovery trend in most regions, although there were differences in the degree of improvement.

B. Financial Developments

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

Regarding developments in financial markets, some members said that long-term interest rates, which were on an upward trend worldwide, warranted careful monitoring. Some members pointed out that the U.S. dollar had been depreciating against the yen recently, partly reflecting market participants' concern about issues relating to the renminbi and global imbalances, and thus future developments in the foreign exchange market and their effects should be watched carefully.

C. Outlook for Economic Activity and Prices

With regard to the outlook for economic activity and prices, members agreed on the following assessment: Japan's economy was likely to experience a sustained period of expansion, with domestic and external demand and also the corporate and household sectors well in balance over the course of fiscal 2007. Some members said that the level of economic activity was becoming relatively high recently, and "expansion" would be an appropriate term to describe future developments if the economy continued to grow.

Members pointed out the following as the background to their economic outlook. First, exports were likely to remain on the increase, reflecting the continuing expansion of overseas economies. Second, corporate performance was likely to continue to be strong even with the effects of high crude oil prices factored in. Third, strong corporate performance was likely to continue benefiting the household sector. And fourth, the extremely accommodative financial conditions were likely to support private demand.

Many members expressed the view that, given that the current recovery of the economy had already lasted for four years and three months, the growth rate was likely to slow gradually toward the potential growth rate as the current recovery of the economy matured. One member elaborated on this point, saying that although the strength in the corporate sector was likely to continue, the growth in business fixed investment was expected to fall off gradually due to the capital stock cycle. The member continued that the driving force of economic recovery would shift from the corporate sector to the household sector, and thus a virtuous circle was likely to be maintained.

Regarding the output gap and the potential growth rate, members agreed on the following points based on new estimates. First, the output gap in the economy had closed. And second, the potential growth rate had risen to the 1.5-2 percent range partly because the "three excesses" in the corporate sector were almost resolved and resources were being allocated more efficiently. One member said that, since Japan's economy was in the process of returning to a sustainable growth path after a prolonged adjustment phase, uncertainties pertaining to the estimation of the output gap and the potential growth rate on a real time basis should be borne in mind.

With regard to prices, members agreed that, given this economic outlook, the environment for prices would continue to improve, as it was likely that the output gap would improve gradually and downward pressures from declining unit labor costs would weaken. Members concurred that domestic corporate goods prices had been exceeding the October projection, reflecting higher international commodity prices and the weaker yen in the second half of 2005, and were likely to continue increasing. Members agreed that the year-on-year rate of increase in the CPI was likely to gradually rise.

Members said that they had made their economic forecasts based on a new assumption that policy interest rates were time-variant, referring to market interest rates. They agreed that this would ensure consistency with developments in other financial variables, such as long-term interest rates and stock prices, on which members based their forecasts. One member said that, in order for this new assumption to be beneficial, it was important to avoid possible misunderstanding that the Bank was committed to conducting monetary policy based on a specific policy interest rate path.

With regard to upside and downside risks to the above outlook, members raised the following three points in relation to economic activity: the growth path of the global economy; the possibility of inventory adjustments; and an acceleration of business fixed investment. They also raised the following three risks to prices: the impact of the emerging positive output gap; the path of the prices of crude oil and other international commodities; and the impact of an increase in the potential growth rate.

As for the growth path of the global economy, many members warned that there was a risk that overseas demand would deviate downward from the outlook due partly to a rise in long-term interest rates. One of these members said that the direct impact of the rise in crude oil prices on Japan's economy was expected to be limited, as its energy efficiency was high. However, attention should be paid to the indirect effects via overseas economies, because the rise in crude oil prices was fundamentally a reflection of an increase in demand worldwide and crude oil prices were likely to remain at high levels. A few members commented that growth of the world economy had been stronger than expected, and risks of upward deviation from the outlook should also be noted.

Some members said that attention should be paid to the risk of inventory adjustments materializing in the future, given the basic scenario that the current economic recovery was likely to mature and the uncertainty regarding developments in IT-related demand. However, the impact of possible inventory adjustments on the overall economy would probably not be significant.

With regard to an acceleration of business fixed investment, a few members said that in the October 2005 Outlook Report the Bank described it as an upside risk to the outlook, but in the April 2006 Outlook Report it should mention not only the upside risk but also a risk of a subsequent slowdown, given that the output gap had already closed. They added that, since developments in business fixed investment could be significantly affected by the accommodative financial environment, an acceleration of business fixed investment should be noted as one of the risks that were most relevant to the conduct of monetary policy, in terms of the second of the two perspectives in the new framework for monetary policy introduced in March 2006.

As for the outlook for prices, some members said that the sensitivity of prices to changes in the output gap was currently weak, partly reflecting globalization, but the expected inflation rate might be revised upward as the output gap became positive in the future. A few members commented that, if the potential growth rate increased, continued momentum for economic expansion might not give rise to inflationary pressure immediately due to downward pressure on prices from the supply side.

Regarding the conduct of monetary policy, members assessed economic activity and prices from the two perspectives. In terms of the first perspective, which concerned the outlook deemed most likely by the Bank for economic activity and prices two years in the future, members agreed that Japan's economy was likely to achieve sustainable growth under price stability.

Members then exchanged views in terms of the second perspective, which was examining risks that were most relevant to conducting monetary policy, looking over a longer time horizon. Many members expressed the view that an accommodative monetary environment would probably be maintained for some time, and in this situation, the stimulus from monetary policy to economic activity and prices might be amplified and there was a risk in the medium to long term of larger economic swings, resulting in large fluctuations in the rate of inflation. A few members commented that, even if economic activity was less robust and the inflation rate lower than expected, the risk of the economy falling into a vicious circle of declining prices and deteriorating economic activity had become smaller, since the Japanese financial system had regained stability and the economy had now cast off excesses in production capacity, employment, and debt.

With regard to the future course of monetary policy, as a result of the assessment of economic activity and prices described above, members concurred that the Bank should explain the following points clearly. First, it seemed probable that the accommodative financial conditions ensuing from very low interest rates would be maintained for some time following a period in which the uncollateralized overnight call rate remained at effectively zero percent. And second, through and beyond this stage, the Bank would adjust the level of interest rates gradually in the light of developments in economic activity and prices. One member said that, although these two points were essentially identical to what was explained at the time of the termination of the quantitative easing policy, it would be worthwhile to give the same message based on the assessment of economic activity and prices over the course of fiscal 2007.

Some members commented that it should be noted that market participants tended to pay keen attention to the Bank's next policy action. They continued that, under the new framework, it was important for the Bank to describe carefully its assessment of the outlook for economic activity and prices from the two perspectives and present a consistent stance on the conduct of monetary policy in a transparent and timely manner, as this would contribute to stabilizing the expectations of market participants and the public.

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

On the monetary policy stance for the immediate future, members agreed that, based on 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.

Some members said that, although the outstanding balance of current accounts at the Bank had decreased to around 20 trillion yen without any major disruption, the Bank should continue to closely monitor conditions in the money market in reducing the outstanding balance of current accounts.

IV. 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. The government considered that it was necessary to ensure that this improvement continued.
(2) Ensuring the sustainability of the economic recovery and overcoming deflation were the most important policy tasks the government should tackle together with the Bank. All possible efforts should be made to ensure the overcoming of deflation and prevent the economy from weakening again, and thus the government would like the Bank to firmly support the economy from the financial side by maintaining a zero interest rate environment.
(3) The government considered that, in order to ensure market stability, the Bank, as the central bank, needed to be more careful in lowering the outstanding balance of current accounts at the Bank, which was currently at around 20 trillion yen, and also closely monitor developments in overall interest rates including long-term interest rates.
(4) The April Outlook Report, whose text would be decided at the meeting, had been attracting attention because it would be the first since the Bank's introduction of the new framework for the conduct of monetary policy in March. In order to prevent financial markets from becoming unstable due to various speculations regarding the future conduct of monetary policy, the government would like the Bank to explain its view clearly to market participants and the public in line with its thinking concerning the future course of monetary policy in the April Outlook Report.

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) Concerning the April Outlook Report, the Policy Board members had discussed the outlook for economic activity and prices two years into the future, and concurred that Japan's economy was likely to continue expanding with balanced domestic and external demand and that it was likely to achieve sustainable growth under price stability. However, crude oil prices, which were at high levels, could have adverse effects not only on overseas economies, but also on Japan's economy. The government considered that, although the economy's excess supply had mostly been eliminated, careful attention should be paid to downside risks to economic activity and prices.
(3) 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.
(4) To prevent the financial markets from becoming unstable after the release of the April Outlook Report due to speculation regarding the future conduct of monetary policy, 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, thereby making it easier for market participants and the public to form an economic outlook and stabilizing their expectations.

V. Votes

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 chairmanformulated 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.

VI. Discussion on the Outlook for Economic Activity and Prices

Members discussed the draft of the Outlook for Economic Activity and Prices (consisting of "The Bank's View" and "The Background"), and put "The Bank's View" 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 28, 2006 and the whole report on May 1, 2006.