TOKYO - The Bank of Japan (BOJ) stood pat on monetary policy on Tuesday but vowed timely action when needed, setting the stage for possible easing next month when it has clarity on political leadership and the strong yen's damage to the slowing economy.
But Governor Masaaki Shirakawa offered few clues on what exactly the BOJ may do next and said monetary authorities could not control foreign exchange rates, triggering yen buying on speculation no aggressive easing was on the horizon.
"The dollar approached its 15-year low of 83.58 yen because of disappointment over Shirakawa's comments," said Keiji Matsumoto, currency strategist at Nikko Cordial Securities.
"He doesn't seem to suggest additional easing. Unless the BOJ fully downgrades its economic assessment, it will not take new additional steps. The dollar/yen could fall to around 82 yen."
Still, government pressure on the BOJ for more aggressive steps will likely grow in coming months with the economy expected to slow and as a leadership battle in the ruling party raises the chances of looser fiscal policy, analysts say.
Japanese government bonds tumbled in the last two weeks on worries of a possible shift away from Prime Minister Naoto Kan's efforts to rein in Japan's huge debt pile if he loses a Sept. 14 vote for the party's top spot to powerbroker Ichiro Ozawa.
Media surveys suggest Ozawa could win and investors are speculating he may be forced to issue more bonds to keep spending promises made when the party swept to power last year.
"So far, the market expectation is that Ozawa would pursue more fiscal expansion than Kan, and the market has to some extent priced in the possibility that Ozawa may become the next prime minister," said Makoto Yamashita, chief Japan interest rate strategist at Deutsche Securities.
"Fiscal expansion can easily be associated with a rise in government pressure on the BOJ to ease. And there are many market players who are looking at it that way."
Others expect the BOJ to come under pressure no matter who wins the battle to head the Democratic Party of Japan.
"The BOJ has a tricky political road regardless of who leads the Democrats. Ozawa might pressure the BOJ, but if Kan stays and there's no big fiscal stimulus, this could also pressure the BOJ," said Frederic Neumann, co-head of Asian economics at HSBC in Hong Kong.
No aggressive action?
After easing policy just last week, the BOJ kept interest rates on hold at 0.1 percent on Tuesday but warned that it would take appropriate and timely action when necessary.
The central bank also repeated that it needed to watch out for downside risks to growth amid increasing uncertainty over the outlook for the US economy, which has jolted currency and stock markets in recent weeks.
But market players see a small chance of aggressive easing steps from the Japanese central bank as it stuck to its forecast of a moderate economic recovery, and Shirakawa said monetary policy was not directly aimed at the yen.
"We are always considering various policy options," Shirakawa told a news conference. "But monetary authorities are unable to control currency rates freely ... We are carefully watching how the yen's rise impacts the Japanese economy."
The yen briefly climbed to 83.70 against the dollar, near the 15-year high hit last month, following his comments.
Japanese policymakers have tried to talk down the yen and threatened to intervene in the currency market after its surge.
The BOJ also stands ready to ease further if the yen soars at a pace of 1 to 2 percent in a single day. Otherwise, it hopes to wait until next month, when it is seen revising down its economic and price forecasts in a semiannual report due on Oct. 28.
The BOJ boosted its cheap loan scheme on Monday of last week, bowing to government pressure for steps to protect the fragile recovery. But the move did little to deter yen gains or stock price falls as investors saw it as a symbolic gesture with little effect in supporting the economy and beating deflation.
That has led some BOJ officials to believe that bolder action is needed to send a clearer message to markets that it is determined to keep the strong yen from harming the economy.
There is no consensus yet on what the next step should be, but the list of options includes a return to zero interest rates and an increase in the bank's government bond purchases.
Expectations of further monetary easing have pushed down the short end of Japan's bond yield curve, while the long end has been pushed up by speculation that Ozawa, if he wins next week's vote, may take a more fiscal expansionary stance than Kan.
But the yield curve has flattened beyond the 10-year zone lately as investors hunting for bargains trimmed earlier losses in the superlong sector, suggesting that the recent sharp rise in yields may have started to peter out.
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