TOKYO (Reuters) - The Bank of Japan offered banks more short-term funds after an emergency meeting on Tuesday, relieving government pressure on the central bank to help avert another recession before upper house polls next year.
Markets primed for a return to full quantitative easing reacted with disappointment to the decision to offer 10 trillion yen in three month funds at 0.1 percent. Analysts said the funds would do little to tackle deflation, although by lowering yen lending rates they may check the currency's rally.
The prime minister and other ministers welcomed the move, suggesting the main outcome of the meeting was to publicly mend fences with the government, which was pressing the BOJ for a policy response to deflation and the risk of a new recession.
"If the BOJ were free from pressure, they wouldn't have done anything, because they've been saying their assessment hasn't changed," said Dariusz Kowalczyk, chief investment strategist at SJS Markets in Hong Kong.
By yielding to political pressure, the BOJ had left the door open to yet more demands as Japan grapples with the fallout of last year's recession, the worst on record, analysts said.
"This isn't the end of the story," said Richard Jerram, chief Japan economist at Macquarie Securities in Tokyo.
"There are going to be more periods of government pressure and more periods of BOJ response."
Governor Masaaki Shirakawa, who holds talks with Prime Minister Yukio Hatoyama on Wednesday, said the decision had nothing to do with government pressure and cast it as an attempt to contain the fallout of Dubai's debt woes.
"We can say this is quantitative easing in the broad sense that we are trying to ensure banks are not faced with (liquidity) constraints," he said after the meeting, at which the BOJ left interest rates unchanged at 0.1 percent.
Few economists saw the move as a return to quantitative easing -- a policy of flooding banks with cash to stimulate lending -- which the BOJ pioneered as it tried to pull Japan out of deflation earlier this decade.
Other central banks adopted variations of the policy as the credit crisis triggered bank failures last year and global recession.
With the world economy recovering, most of the BOJ's peers are on hold. The European Central Bank may even begin unwinding ultra-loose policy this week.
"Today's step is clearly not what many people would see as quantitative easing," said Takahide Kiuchi, chief economist at Nomura Securities in Tokyo.
"I think markets wanted something much bigger."
The finance minister had raised market expectations by talking up the benefits of quantitative easing after weeks of government pressure for a BOJ response to the economic crisis. One minister said the BOJ was "asleep at the wheel."
SOMETHING MUCH BIGGER
Speculation reached fever pitch after the BOJ called an emergency meeting. When the funding measure was announced, the dollar fell against the yen and 10-year Japanese government bond futures trimmed gains as investors recoiled in disappointment.
"There will hardly be an impact on the real economy," said Hirokata Kusaba, senior economist at Mizuho Research Institute.
The BOJ has long said that with interest rates near zero there was little it could do to revive demand.
Shirakawa said Tuesday's BOJ move was a response to a yen rally and a drop in stocks last week after debt troubles in Dubai briefly threatened to reignite the turmoil of the credit crisis.
The operation may succeed in bringing down some money market rates and commercial paper yields that have stayed high despite the BOJ's other efforts to ease strains that emerged during the crisis. The BOJ scrapped some support for credit markets in October because its facilities had fallen into disuse.
There may also be an impact on the yen which hit a 14-year high against the dollar last week, triggering concern that it could push Japan deeper into deflation.
One effect could be to pull down three-month yen LIBOR compared with dollar LIBOR.
The spread between the respective dollar and yen LIBOR is -4 basis points and has been negative since August, making the U.S. dollar a more attractive funding currency for the carry trade.
"The impact may be a small one but it looks enough to help check the yen's rise," said Masayuki Ebira, director at Barclays Bank.
The government appeared to have been placated for now.
"The BOJ's action at this time is highly welcome," Hatoyama told reporters.
Ministers also welcomed the move with one saying he hoped the measure would bring down long-term interest rates. That would reduce borrowing costs for the most indebted government in any rich nation and lower the risk of recession.
After rebuffing government criticism that its view of the economy was too rosy, the central bank had shown signs of caving in and some analysts had expected a return to quantitative easing. Others had forecast purchases of more government bonds.
But the BOJ stopped well short of both responses. It did not amend the range of collateral against which it would lend the new three-month funds, a move that could have channeled some cash to small firms which the government says are starved of credit.
Hatoyama's Democratic Party, which rode to power promising to cut spending on public works so it could offer more support to households, fears another recession in early 2010.
That could hurt the DPJ's chances of winning an outright majority in the upper house to avoid relying on two small, vocal coalition allies to get measures passed unopposed.
LINKS
> Graphic on fiscal pressures building in Japan:
. http://r.reuters.com/paw97f
> Other graphics...............
> BOJ moves disappoint.........
(Additional reporting by Stanley White; Writing by Leika Kihara; Editing by Dayan Candappa and Hugh Lawson)
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