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A woman in a traditional costume walks past a shop holding a bargain sale at a shopping district in Tokyo on Friday. Japan's core consumer prices fell for the 17th straight month in July on an annual basis in a sign that deflation remains deeply entrenched, boding ill for a fragile economy faced with a surging yen.

KIM KYUNG-HOON/Kim Kyung-Hoon/Reuters

Straining to kick-start a flagging economy and combat deflation, the Bank of Japan cut its key interest rate to zero and unveiled plans to buy more government bonds along with a slew of unconventional private sector assets.

The central bank reduced its official target rate from 0.1 per cent to a range of zero to 0.1 per cent, and said it would maintain "the virtually zero interest rate policy" until it sees clear signs of sustained price stability after years of flat or falling prices.

The bank also took the unusual step of setting plans to acquire a range of assets, including government bonds, real estate investment trusts, exchange-traded funds, commercial paper and corporate bonds - its latest effort at so-called quantitative easing.

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The Bank of Japan is setting aside ¥5-trillion ($60-billion) for the new asset purchases, of which ¥1.5-trillion will be earmarked for private sector assets and the rest for more government bonds.

Noting that there is "little room for a further decline in short-term interest rates," the bank said it will turn to these unconventional measures to encourage "the decline in longer-term interest rates and various risk premiums to further enhance monetary policy."

Pulling no punches, the bank called the asset purchases an "extraordinary" temporary measure.

The moves are important because they signal the Bank of Japan is on board with government efforts to reverse deflation, bring down the value of the currency and stimulate the economic recovery, said Pierre Ellis, a senior economist with Boston-based Decision Economics.

Practically, however, Japan will be hard pressed to reinvigorate an economy that has largely stalled for years despite rock-bottom interest rates and previous easy-money policies.

The bank's decision was triggered by a worse-than-expected update for the domestic economy, Bank of Japan governor Masaaki Shirakawa said.

"Although Japan's economy still shows signs of a moderate recovery, the pace of recovery is slowing down, partly due to the slowdown in overseas economies and the effects of the yen's appreciation on business sentiment," the bank said in its statement.

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The Bank of Japan's interest rate move was seen as largely symbolic, since rates have already effectively been near zero for years.

The relatively small amount set for asset purchases represents a modest expansion of the bank's balance sheet and would likely have no impact on long-term rates, which are already low, analysts said. The 10-year yield fell below 1 per cent in August and slid slightly on Tuesday.

The move to acquire private sector assets, however, could expand into a major balance sheet expansion if the bank launches a more aggressive stimulus effort. Of the ¥1.5-trillion, two-thirds will go toward bonds, leaving ¥500-billion to snap up exchange-traded funds and Japanese REITs.

In any case, the bank is sending a clear signal to the markets that the government is prepared to back up its vow to bring down long-term rates and risk premiums through direct intervention in the marketplace.

The actual impact of the central bank's latest intervention will be fairly mild, analysts said.

"Japan has taken baby steps for the last 15 years, so why be brave now?" said Eric Lascelles, a macro strategist at TD Securities. "These are fairly cautious steps."

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Indeed, the Japanese yen, whose recent strength has hurt exports and darkened the economic outlook, strengthened slightly after the bank's announcement.

"The market's judging that whatever they do, they can't offset the power of international capital flows," said Decision Economics' Mr. Ellis.

Even at an official level of zero, Japanese real rates remain higher than those in the United States. Adding the overnight loan cost to the level of deflation put Japanese rates 0.22 percentage points above the U.S. on Tuesday.

The bank may have more success reducing risk premiums, but corporate bond spreads are not particularly high by historical standards, Capital Economics said in a commentary.

Nevertheless, the bank "does deserve some credit for being willing to take a new tack, or at least to resurrect some crisis response policies that had expired," the economics research firm said.

Before the policy announcement, some Japanese analysts were predicting an intervention of as much as ¥20-trillion.

Japan will not be alone in pouring more stimulus cash into sickly or sluggish economies. While other central banks and governments have talked bravely of cutting back or removing emergency financial measures, the U.S. and several European governments have had to rethink those plans in the face of a pronounced deterioration.

Bank of England policy makers are expected to review more quantitative easing options at their meeting this week, and the Federal Reserve has already signalled its readiness for further aggressive intervention.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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