Japan risks all on rate rise

Japan's central bank ended its "money-for-nothing" policy yesterday with a controversial decision to lift interest rates for the first time in 10 years, despite a warning by the International Monetary Fund that this could derail the recovery.

Defying prime minister Yoshiro Mori, the bank's policy board said the world's second-biggest economy was strong enough to kick away the crutch of zero interest rates, the lowest the world has seen.

After a seven-hour meeting yesterday, a majority of the nine members of the policy board said the rate, put in place at the depth of the recession 18 months ago, was no longer justified.

"The Bank of Japan feels confident that Japan's economy has reached the stage where deflationary concern has been dispelled, which is the condition for lifting the zero interest rate policy," the panel said.

However, the move is likely to be viewed with suspicion in America and Europe, where authorities remain concerned about the durability of the upswing and the consequences for the rest of the globe if Japan sinks back into recession.

Those worries were reflected in a detailed assessment of the Japanese economy published yesterday by the IMF which said: "An early move to firm the stance of macroeconomic policies would pose risks for the recovery."

The Bank of Japan based its decision on forecasts that Japan's output will expand by 2% this year, having eked out its first growth for three years in 1999.

However, the move to increase the overnight rate by quarter of a point is as much motivated by political as economic concerns.

The Bank of Japan's autonomy, granted only two years ago, has been questioned by ruling party leaders who say the economy is still too weak to withstand a tightening of monetary policy. The government also wants to maintain low borrowing rates because it has run up a record public debt on which it has to pay interest.

Mr Mori acknowledged his frustration at the central bank's decision. "I can't deny feeling that this was premature," he said. "I call upon the Bank of Japan to continue conducting appropriate and flexible operations in the market."

The decision is a victory for central bank governor, Masaru Hayami, who said the "abnormal" situation of lending money for nothing slowed impetus for reform and encouraged irresponsible lending.

The battle between government and central bank has received the sort of media coverage usually reserved for general election results or royal romances, and television stations yesterday totted up the winners and losers.

The rate rise will come as a relief to millions of pensioners, who rely on savings that have been generating almost no interest for the past two years.

But higher borrowing costs will punish small firms, about two-thirds of which lost money last year. The precarious state of much of corporate Japan was underlined last month by the collapse of the Sogo department store chain, the second-biggest failure in Japan's history.

"We understood that the zero rate was only a temporary measure, but it is too early to lift it now," said Kosaku Inaba, head of the Japanese chamber of commerce.