Bank of Japan holds rates at zero

Japan yesterday surprised the markets by keeping its zero interest rate policy on hold despite earlier preparing dealers for an increase.

However, the Bank of Japan signalled that a long period of deflation had come to an end and rates would begin to rise in coming months. The central bank said the economy was beginning to show signs of inflation as economic activity picked up in recent months.

But the positive note struck by the BoJ will be disputed today by McKinsey, the American management consultant, which has published a highly critical assessment of the Japanese economy, describing the past decade as a journey from "model to muddle".

In a report published three days before the country hosts the annual economic summit of the Group of Seven leading industrialised nations on the island of Okinawa, Mckinsey said the only way Japan could turn itself around was by adopting a systematic programme of reform aimed at increasing competition.

The hectoring tone of the report is likely to irritate the Japanese government, which will see it as another attempt to bully it into rebuilding the economy in the image of the US. But the thrust of its message will be welcomed by progressive policymakers at the Japanese finance ministry who believe politicians have been too slow to grasp the nettle of economic reform.

"The Japanese system does have to change to more like the US economy," one said. "We need more competition and originality but at the same time US economic success can't go on forever and when it stops the social strains will show. Stability oriented policies are needed."

Despite more than a year of interest rates at zero and eight different fiscal packages worth nearly $800bn (£500bn), gross domestic product per head of the population had grown by a meagre 0.6% since 1990, compared with 1.7% in the US, said McKinsey

Meanwhile, the unemployment rate has risen from just over 2% to around 5% and public debt to GDP ratio has doubled to nearly 120%, twice that of the US and Germany.

"In short, the past decade has seen the Japanese economy go from model to muddle," said McKinsey.

The company said that Japan had a "dual economy" with a world-beating portion, comprising cars, steel, machine tools and consumer electronics, which was exposed to international competition, and a remaining 90% which was not.

"Save for their national origin, these [poor performing] companies share nothing with Toyota," said the report.

"They are subscale, poorly managed, antiquated, insulated from competition, and woefully unproductive.

"The productivity of this portion of the Japanese economy stands at a mere 63% of US levels.

"It is the source of Japan's ills, and the Japanese economy will not rebound until the performance of these companies begins to turn around."