Japan agrees 2% inflation target and asset purchases

The Bank of Japan (BOJ) has agreed to double its inflation target to 2% and ease monetary policy, meeting key demands of Japan's new government.

Japan's central bank has guarded its independence and there were fears it may resist Prime Minister Shinzo Abe's calls for it to do more to help growth.

But the BOJ has gone further than many analysts predicted, offering to do open-ended asset purchases from 2014.

The BOJ measures are expected to pump billions of yen into the economy.

"This is very good news," said Brian Redican, from Macquarie in Sydney. "For once, the BOJ has been more aggressive than the market expected. The government is clearly forcing the pace of change, which is no bad thing.

"The BOJ has talked about targeting inflation for years without any success, but these changes are more credible."

Cost cutting

Japan has been caught in almost two decades of on-and-off deflation, or falling prices.

This has hampered attempts by successive governments to stoke growth, some economists argue, because it has overshadowed consumers and companies, making them less optimistic about the future and, as a result, less likely to spend.

Economists say that deflation encourages people to put off spending decisions in the expectation of lower prices, and makes it harder for borrowers such as Japanese businesses to earn sufficient income to repay their debts.

As a result the entire economy becomes stuck in a "liquidity trap" of falling prices and depressed spending.

In his election campaign and since he won office, Prime Minister Abe has been arguing that Japan needs to move quickly and decisively to halt deflation.

He has promised that his government will boost state spending in areas such as infrastructure to help spur growth, and has also argued that the Bank of Japan needs to play a more active role.

It seems as if the central bank has been listening.

At the end of its two-day policy meeting on Tuesday, the Bank of Japan said that starting from 2014 it will step up its asset buying programme, making it open-ended.

In a rare joint statement with the government, it explained that it would buy about 13tn yen ($145bn; £92bn) in assets each month starting in January 2014. It added that this would continue for as long as was necessary.

The plan, which is similar to measures taken by the US Federal Reserve, includes about 2tn yen in Japanese government bonds, as well as about 10tn yen in treasury bills.

"The BOJ will pursue powerful monetary easing by maintaining virtually zero interest rates and purchases of financial assets as long as it deems appropriate," the statement said.

Market moves

One of the main headaches for Japan in past years has been the strength of the yen. This has made its exports more expensive and, in the view of Prime Minister Abe, acted as a significant brake on growth.

The central bank's plan to pump money into the economy is seen as weakening the yen as well as stoking inflation - and hopefully growth. The currency had already fallen against the US dollar and other currencies ahead of Tuesday's announcement.

In the last two months, the yen has dropped 13% against the US dollar, while Tokyo's main stock index the Nikkei 225 has risen.

But while the Japanese authorities hope that their actions will weaken the yen and boost stocks further, on Tuesday investors raised some shorter-term concerns - in particular the delay in implementing the asset buying plan until the start of 2014.

By the close of trading on Tuesday, Tokyo stocks had given up their initial gains on the BOJ statement, and were down 0.4%.

"The stock market will digest the move today and then probably take a breather, but in the short term I don't see it falling very far as there are no incentives for a sell-off," said Hideyuki Ishiguro, senior investment strategist at Okasn Securities in Tokyo.