The Bank of Japan said it was growing slightly more optimistic about the economy and financial conditions today, likely bringing it a step closer towards phasing out some of its measures to support corporate funding.
But record deflation, rising job losses and weak capital spending may complicate the debate on the timing for exiting its special measures, which include buying commercial paper (CP) and corporate bonds from banks.
"The BOJ may look toward ending some of its steps for corporate finance, but when you compare Japan with other economies, no one is really expecting inflation in Japan," said David Cohen, director of Asian economic forecasting at Action Economics in Singapore.
The central bank's policy board voted unanimously to keep interest rates on hold at 0.1 per cent as widely expected.
"Financial conditions remain severe but are increasingly showing signs of improvement," the BOJ said in a statement.
Mr Cohen said: "The BOJ is understandably cautious about the remaining uncertainties to the economic outlook, but interest rates are as low as they can go and will likely stay there for some time."
BOJ officials will scrutinise the bank's closely watched tankan business confidence survey due on October 1st for clues on whether corporate sentiment and spending are improving at smaller firms as well as larger ones to help it decide when to phase out its unconventional steps.
The Reuters Tankan, a leading indicator for the BOJ's survey, showed today that manufacturers were at their least pessimistic in a year in September and expect conditions to improve further in the next three months.
The central bank may also be concerned about fiscal spending under the new administration of Prime Minister Yukio Hatoyama.
"The BOJ is likely to err on the side of caution as it is unclear what policies the new government will undertake," said Naomi Hasegawa, a senior fixed-income strategist at Mitsubishi UFJ Securities.
Central banks around the world have begun debating how and when to phase out their emergency steps to contain the damage wrought by the worst global financial crisis in decades, but most are not expected to do so until well into next year.
The BOJ said exports and output were increasing thanks to a recovery in overseas markets, especially in emerging economies.
It maintained its view on prices, saying annual core consumer price falls would narrow in the latter half of the year to March 2010.
The central bank is widely expected to keep rates at 0.1 per cent until at least March 2011.
BOJ Governor Masaaki Shirakawa is likely to repeat the view at his post-meeting news conference that price falls will not accelerate enough to warrant further monetary easing.
The BOJ has extended its support measures for corporate funding, including buying commercial paper (CP) and corporate bonds from banks, to the end of December.
But the average issue rate for one-month CP fell to 0.21 per cent in August from a peak of 1.34 per cent last December, and there is a growing feeling at the BOJ that it could let some of its special steps expire in December without disrupting markets.
Japanese exports and output have bounced back from a steep fall triggered by the global crisis, helping the economy return to growth in the second quarter.
A survey by the Ministry of Finance and the Cabinet Office also showed big manufacturers turned optimistic about business conditions in the three months to September compared with the previous quarter.
Reuters