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Thursday, Feb. 22, 2007
Rate hike means both pain and gain
The Bank of Japan's Policy Board on Wednesday raised the key short-term interest rate by a quarter point to 0.5 percent. Following are some explanations on how the interest rate hike will impact the Japanese economy:
How are interest rates controlled?
The key interest rate people talk about is the unsecured overnight call rate, which financial institutions use for capital transactions that mature the following day. The BOJ guides that rate.
The central bank steered the figure Wednesday to 0.5 percent by supplying or draining funds from the call market through open market operations.
If the unsecured overnight call rate is raised, financial institutions must pay more to make transactions. So they pass that cost on to consumers by raising interest rates on things like deposits and loans.
When was the last time the BOJ raised the interest rate?
The rate was last hiked in July, when the central bank ended the unorthodox "zero-interest-rate" policy, which had been in place for more than five years. Under that policy, the central bank was effectively handing out virtually interest-free loans. This helped whip up a phenomena called the "yen-carry trade."
Who will benefit from the rate increase? Who will suffer?
Depositors will benefit and borrowers will suffer.
After the rate hike in July, the average interest rate on a regular bank deposit jumped to 0.099 percent in December from 0.001 percent in June.
For individual depositors, this meant that a 1 million yen bank deposit would yield 999 yen in interest, instead of just 10 yen for the year.
But banks' rates vary. Most major city banks have already set their rates at 0.1 percent, but Sumitomo Trust & Banking Co. set it at 0.2 percent to attract more depositors.
How will the hike affect household spending?
Pensioners living on interest income will benefit from the higher rate. But not by much -- Japanese interest rates remain the lowest among the major economies.
People with mortgages, however, stand to lose.
Those with floating interest rates will have to pay more. In October, Bank of Tokyo-Mitsubishi UFJ, Mizuho Bank and Sumitomo Mitsui raised the floating rate for housing loans to 2.625 percent, up 0.25 percentage points.
Those betting interest rates will continue to rise should probably choose a fixed-rate mortgage rate longer than 35 years rather than a floating rate mortgage.
What about businesses?
Companies that have extensive debt will have to pay more interest. Market watchers say firms in the transportation and utilities industries that have invested heavily in huge projects will likely struggle with the higher rate.
But the impact on most businesses will likely be minimal, analysts say. Even though Japan's interest rate is now 0.5 percent, it is still tiny compared with the United States and European countries, where the key rate is between 3.0 percent and 5.0 percent.
However, since Japan's interest rates were close to zero for nearly six years, analysts say market players and the media are now unaccustomed to dealing with the unpredictability of a fluctuating rate.
Why has there been government resistance to the hike?
For one thing, the government feels consumer spending remains sluggish and inflation has yet to take hold, which means a rate hike could again torpedo the modest economic recovery.
An interest rate hike also increases Japan's exorbitant debt-servicing costs and expands the massive public debt, which in various forecasts has been expected to exceed at least 150 percent of GDP. It remains the largest public debt in the industrialized world.