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Japan's stimulus sharpens risk of global currency clash

 Bank of Japan Governor Masaaki Shirakawa speaks at a news conference room in Tokyo September 19, 2012. Shirakawa said on Wednesday that Japan's economic recovery may be delayed by six months due to a prolonged slowdown in global growth.

Kim Kyung-Hoon/Reuter

Japan's central bank has joined the U.S. Federal Reserve in new emergency stimulus measures that together could spark a currency war with smaller emerging nations.

Faced with a stagnating economy, a rising yen and weaker export markets, the Bank of Japan opted to expand a program that injects cash into an already flush financial system. The plan, which involves buying government bonds from lending institutions, will grow by an additional ¥10-trillion ($124-billion) to ¥80-trillion.

The move follows last week's similar action by the Fed and the European Central Bank's decision to buy the bonds of troubled euro zone countries in a bid to stem a worsening debt crisis.

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It also comes in the wake of rising tensions between Japan and key trading partner China over territorial claims to a group of small islands in the East China Sea.

The central banks' moves are to designed to ease the hangover of the Great Recession – not enough growth, too much debt and uncomfortably high rates of unemployment in the developed world.

But they come with a catch: They carry the potential to trigger retaliation from smaller economies worried about safeguarding their own trade and currency interests.

Analysts said some emerging-market countries would respond by trying to weaken their own currencies – perhaps by instituting new controls to limit the amount of foreign money flooding into their countries in search of higher returns than can be found in developed countries such as Japan and the U.S. where interest rates are extraordinarily low.

"The likelihood of a similar pushback by emerging-market economies is likely to be easing of their own or capital controls to try and stem the flow of hot money looking for yield," warned Michael Hewson, senior market analyst with CMC Markets in London.

"We would suggest markets have almost come full circle from the fall of 2011, when the G4 central banks announced increasingly aggressive monetary policy, unleashing a risk rally and adding fuel to the 'currency war,'" said Camilla Sutton, chief currency strategist with Bank of Nova Scotia.

Bank of Japan governor Masaaki Shirakawa insisted that the unexpected announcement of monetary easing stemmed from recent weak economic data – signalling annual growth of only about 1 per cent or less in the second half of the year – and was not a response to last week's measures by the Federal Reserve, which is expected to drive down the value of the greenback. He also denied that the growing friction with China was a factor in the bank's decision.

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"Overseas economies are slowing more than we anticipated, which is why we downgraded Japan's economic view," Mr. Shirakawa told a news conference after the decision. "Japan's economic recovery could be delayed by about half a year."

The Fed also insisted that its bond-purchasing plan is not aimed at weakening the U.S. dollar. But the central bank is well aware that its policy is "U.S. dollar negative," Ms. Sutton said in a note.

Like the Fed, the Bank of Japan is working with a depleted tool kit, because interest rates are effectively at or below zero.

But both central banks have unlimited capacity to expand their balance sheets through bond, mortgage and other asset purchases, which put cash into the economy. Yet after more than a decade of easing by the Bank of Japan, economic growth remains feeble, particularly with heavy spending on tsunami-related reconstruction winding down. And the Fed's efforts have so far done more to bolster bank balance sheets and aid equity markets than boost economic growth.

"It's kept their economy moving forward," Sal Guatieri, a senior economist with BMO Nesbitt Burns, said of the Bank of Japan's massive easing. "But it certainly hasn't inspired a strong recovery. The additional asset purchases will provide modest support. but interest rates are so low in Japan, it's difficult to see how much further support this can provide to the economy."

The Japanese move surprised analysts who had expected the bank to wait until its October meeting, when it publishes its influential quarterly survey of business sentiment.

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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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