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The Bank of Japan has reduced the yen’s volatility with its new 10 trillion yen ($113 billion) program aimed at stabilizing interest rates, signaling the start of its plan to normalize monetary policy, Calyon Securities said.

The central bank’s decision to offer three-month loans to commercial banks at a rate of 0.1 percent brought down yen borrowing costs, which should limit gains in the currency in the long run, Susumu Kato, Calyon’s chief economist in Tokyo, said in an interview with Bloomberg News yesterday. The BOJ announced its measures after an emergency meeting Dec. 1.

“It’s important to know it’s the start of exit policies,” Kato said. “The Bank of Japan tried to prevent a pickup in interest rates because that could make the Japanese yen stronger.”

The yen was little changed at 88.20 per dollar today after declining for the past three days. The currency climbed to 84.83 on Nov. 27, the strongest since July 1995. It may decline to 90 versus the dollar by the end of March 2010, Kato said.

“Before stabilizing at 90, there will be some risk of further strengthening of the Japanese yen,” he said. “Maybe close to 80, but that will be the end of the story. After that, it will stabilize.”

Wider Range

The BOJ announced its new loan measures a month after it decided to end an earlier lending program, which included offering banks unlimited collateralized loans. The central bank will accept a wider range of assets such as government bonds and debt issued by local governments. The program has no time limit.

Three-month yen London interbank offered rates, or Libor, stood at 0.286 percent yesterday, three basis points higher than rate for dollar loans, the narrowest spread since Aug. 26, according to British Bankers’ Association. The three-month interbank offered rate fixed in Tokyo, known as Tibor, fell to 0.487 percent yesterday, from 0.514 percent on Dec. 1, according to the Japanese Bankers Association.

The BOJ measure “was directly to control term interest rates,” Kato said. “This is a safety net for a pickup or a jump in term interest rates.”

Dollar loans became cheaper than those in yen in August, reducing demand for so-called carry trades funded in Japan’s currency. In such trades, investors get funds in a country with relatively low borrowing costs and invest in another with higher interest rates paydayloans.

Normalization

The BOJ’s “normalization of interest rates could happen,” Kato said. “That could prevent a large interest-rate differential when the Fed starts raising rates. I don’t think there will be any return of yen carry trades.”

Benchmark interest rates are 0.1 percent in Japan and as low as zero in the U.S., compared with 8.75 percent in Brazil and 3.75 percent in Australia.

BOJ Governor Masaaki Shirakawa called the emergency meeting as political pressure mounted on the central bank to tackle declining consumer prices. The government said on Nov. 20 that the economy is in deflation.

Consumer prices excluding fresh food declined for an eighth month in October, sliding 2.2 percent from a year earlier, the statistics bureau reported Nov. 27. The central bank forecast the declines will extend into fiscal year 2011.

The central bank will refrain from adding any new quantitative easing measures of pumping money into the markets, Kato said. The BOJ introduced quantitative easing steps in March 2001 before suspending them in March 2006.

‘Very Optimistic’

“It’s not the beginning of further monetary easing because the Bank of Japan has been very, very optimistic about economic growth, sustained recovery,” he said.

Consumer prices excluding fresh food, the BOJ’s preferred gauge of inflation, will fall 0.4 percent in the year starting April 1, 2011, while economic growth will rise to 2.1 percent, the central bank said in its semiannual outlook Oct. 30.

“By the end of 2011, maybe zero percent of deflation,” Kato said. “The Bank of Japan isn’t going into further quantitative easing.”

The central bank may start raising borrowing costs in the second half of 2011, shortly after the Federal Reserve does so, Kato said.

The BOJ will keep its overnight rate unchanged through 2010, according to analysts surveyed by Bloomberg News. The Fed may begin lifting its benchmark in the third quarter of 2010, according to a separate Bloomberg survey.

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