Japanese PM owes BoJ boss a debt of gratitude

Martin Foster: In the face of currency movements bordering on critical and with his own future in question, Naoto Kan has found at least one ally in his quest to maintain the recovery.

The US dollar slipped to ¥84.71 on August 11 after the Federal Reserve said the US recovery may slow. The Fed then pumped funds from maturing mortgage-backed securities into treasuries. Investors baulked at lower yields and drove down the dollar as they switched to yen-denominated debt.

Efforts by Japanese officials nudged the greenback above ¥85, but that was still well below average predicted exchange rates of ¥90.18 for large manufacturing enterprises seen in the June survey of business sentiment from the Bank of Japan (BoJ). More than 80 per cent of Japanese jobs are provided by small and medium-sized enterprises - many of which do not invest in offshore plant, and do not have the know-how to avoid the impact of the firm yen at home - and dollar back-ups to ¥84.89 last Thursday highlighted their precarious position.

Major manufacturers, meanwhile, have moved production capability offshore and the outlook may not be as bleak as last time around. Processors, including major car makers, now produce 25 per cent of all goods outside Japan. Further economic stagnation may see the dollar slide to ¥82. Lows of about ¥79.75 were seen in April 1995, and a return to those levels would probably cut Japanese economic growth to less than 1 per cent in the year from next April 1.

The yen is unlikely to get any help from the Japanese authorities who have not intervened since March 2004, and given that a softer dollar is beneficial to US exports there is little reason for the Fed to join any action that would raise the cost of US goods to overseas buyers. The Japanese government is hoping to persuade the BoJ to use lower interest rates to drive down the value of the yen. But the central bank made no move at its monetary policy meetings on August 10 and Masaaki Shirakawa, its governor, has repeatedly said he would not use interest rate policy as a foreign-exchange tool.

The independence of the central bank is enshrined in law but its actions sometimes appear to suggest otherwise. December 1 last year saw the BoJ hold an unscheduled policy meeting where it introduced an entirely new funding operation designed to drive down long-term rates in response to the firming yen. The next day, Mr Shirakawa met the then prime minister Yukio Hatoyama to "discuss" the economic situation. Not many people were fooled but Mr Shirakawa was left in a position where he could claim not to have succumbed to political pressure.

According to the chief cabinet secretary, the current prime minister Naoto Kan spoke with the BoJ governor by phone for 15 minutes yesterday. The sense of urgency to act is far less apparent than in December last year, and despite pressure on the BoJ to guide borrowing rates lower the central bank is now expected to wait until the next policy meeting in September before deciding on any move. Let's not forget it was Mr Kan who decided to talk about higher consumption taxes in the election campaign that last month cost the Democratic Party of Japan its majority in the upper house.

The prime minister is now fighting to keep his party leadership with polls likely next month, and until then his ability to execute policy remains diminished. By agreeing to talk, Mr Shirakawa did Mr Kan a favour by helping to maintain the impression that the prime minister remains in control. Needless to say, as the fifth Japanese prime minister in less than five years, Mr Kan is probably better advised to get his political house in order before putting more heat on the BoJ governor.