Bank of Japan keeps interest rates on hold to fight deflation

The Bank of Japan has again elected to keep interest rates on hold at the low level of 0.1%, as widely expected.

It is anticipated that the Bank will leave rates at the low rate until around 2012 as a result of deflationary pressures.

The world’s no.2 economy exited recession in the second quarter of this year but there have been fears that the return of deflation could stall growth within the economy.

A short period of deflation (where prices fall rather than increase) could be a serious threat to the economy because it deters consumers and businesses from spending in expectation of falling prices.

Deflation was a problem for Japan during its so-called “Lost Decade” in the 1990s in which the economy struggled with falling prices.

In a statement, the Bank of Japan said: “It is a critical challenge for Japan’s economy to overcome deflation.”

It added that it would not tolerate flat prices, let alone deflation. Adrian Foster, head of financial markets research at Rabobank International, Hong Kong, said: “It seems the Bank wanted to get zero out of their price understanding. They’re trying to show that they are going all out to stop deflation.”

Furthermore, the yen’s recent surge to a 14-year high against the US dollar poses a threat to the recovery by making Japanese exports more expensive in the US.

Consequently, while many central banks are gradually withdrawing their stimulus packages, the Bank of Japan recently expanded theirs.

Earlier this month, the Japanese Government agreed to inject a further 7.2 trillion yen ($81 billion; £48 billion) into the economy to prevent it falling back into recession.

However, Japan’s public debt is close to the equivalent of 200% of GDP so fiscal expansion is limited.

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