Bank of Japan raises rates

The Bank of Japan today raised interest rates for the first time in almost six years in a move that reflects growing confidence in Japan's economic recovery.

The nine members of the BoJ's board voted unanimously in favour of a modest hike of a quarter of a percent, suggested by the bank's president Toshihiko Fukui.

"Today's decision will contribute to ensuring price stability and achieving sustainable growth in the medium and to long term," the central bank said in a statement.

Today's rise, which takes immediate effect, came after months of speculation over whether Japan had truly beaten deflation and warnings from senior politicians that ending cheap credit too soon could stifle the country's comeback from 10 years of recession.Japan has kept interest rates at near zero since 2001 in an attempt to end the downward trend in prices and the resulting lower corporate earnings and shrinking salaries that characterized Japan's so-called "lost decade."

But the bank's board appears to have been swayed by recent data showing that, after several false dawns, Japan appears at last to have pulled itself out of recession.

"Japan's economy continues to expand moderately, with domestic and external demand and also the corporate and household sectors well in balance," the BoJ said in a statement. "In this environment, maintaining the previous level of the policy interest rate may result in large swings in economic activity and prices in the future."

Last month, the bank's Tankan survey of business sentiment showed that large firms across the board were planning to increase investment in plants and equipment in FY2006 by more than 11% from last year, the biggest rise since 1990.

The bank said it was confident the economy would continue to expand and that consumer prices would keep rising, a clear sign, it said, that deflation had ended.

Japan's economy has registered growth for five quarters in a row and growth of up to 3% has been forecast for this year. The consumer price index, meanwhile, rose 0.6% in May, the seventh monthly gain.

Analysts said they did not expect the miniscule rise to have a significant impact on the economy, but now that the BoJ has made a clean break with quantitative easing speculation is mounting over the size and timing of subsequent interest rate rises.

Acknowledging fears that higher borrowing rates could stifle recovery, the bank said "very low interest rates will probably be maintained for some time."

Today's decision brings the BoJ into line with central banks in the US and Europe: last month the European Central Bank raised its key interest rate to 2.75% and the US federal reserve has increased rates 17 times in a row to 5.25%.

Most analysts had expected the rise, which they see as crucial to normalising Japan's monetary policy.

"Zero interest rates were a necessary emergency policy," said Jesper Koll, chief economist at Merrill Lynch in Tokyo. "But Japan needs the beginning of a normalisation process. Normality means money isn't free."

The central bank's independence has been severely tested in recent weeks, with several senior government figures urging it not to move too soon and stifle the recovery, an accusation the BoJ faced when it raised borrowing rates in August 2000.

Sadakazu Tanigaki, the finance minister, has repeatedly urged caution and today repeated calls for the BoJ to keep the economy top of the agenda when deciding monetary policy. "We want the central bank to bolster economic growth and help make it sustainable with its monetary policy," he told reporters.

The Nikkei 225 Index fell 252.71 points, or 1.67%, today but the fall was attributed mainly to concerns over rising oil prices prompted by renewed violence in the Middle East.