Bank of Japan’s September report of recent economic and financial developments1 Bank of Japan, Communication, 18 September 2000. * * * The Bank’s view2 Japan’s economy is recovering gradually, with corporate profits and business fixed investment continuing to increase. With regard to exogenous demand, public investment is about to decrease since the implementation of the supplementary budget for fiscal 1999 has peaked out. Net exports (real exports minus real imports) continue to follow a moderate upward trend due to steady developments in overseas economies. As regards domestic private demand, business fixed investment is on an increasing trend. The recovery in private consumption continues to be weak as a whole through lack of notable improvements in employment and income conditions, although there are somewhat positive signs in some indicators. Housing investment is mostly unchanged. Reflecting such developments in final demand, industrial production is increasing. Corporate profits and sentiment continue to improve, and the number of firms that take positive action, such as increasing the amount of fixed investment, is increasing, especially in high-growth sectors. Income conditions of households still remain severe but regular and overtime payments as well as new job offers continue to increase in line with the recovery in corporate activities, and compensation of employees has stopped decreasing. As for the outlook, public investment will decrease, but net exports are expected to continue increasing gradually, reflecting the expansion in overseas economies. In the corporate sector, firms still strongly feel that they have excess equipment and that they should reduce their debts to restore financial soundness. However, it is very likely that fixed investment in high-growth sectors, including those related with information technology services, will increase as corporate profits continue to recover. Moreover, an improvement in corporate profits will increase household income and this in turn is expected to boost private consumption. However, the pace of recovery in household income will be modest for the time being, since firms’ perceptions of excess employment still persist, and thus significant changes have not been observed in their efforts to reduce personnel expenses. Overall, the economy is likely to recover gradually led mainly by business fixed investment, unless there are major adverse external shocks. In addition, the favorable financial environment created partly by the Bank’s sustaining easy monetary stance is expected to continue underpinning the economy. With regard to prices, import prices are rising, reflecting an increase in international commodity prices such as crude oil prices since April. Domestic wholesale prices, notwithstanding the rise in prices of petroleum products reflecting the increase in crude oil prices, are mostly unchanged mainly due to the decrease in prices of electric machinery. Meanwhile, consumer prices continue to be somewhat weak owing to the decline in prices of imported products reflecting the past appreciation of the yen, although prices of petroleum products and electricity increased from the rise in crude oil prices. Corporate service prices are still falling slowly. This report was written based on data and information available when the Bank of Japan Monetary Policy Meeting was held on 14 September 2000. The Bank’s view on recent economic and financial developments, determined by the Policy Board at the Monetary Policy Meeting held on 14 September as the basis of monetary policy decisions. As for the outlook on prices, downward pressure on prices stemming from weak demand is declining significantly while an economic recovery is expected to continue moderately. Upward pressure on prices is likely to arise temporarily from the increase in crude oil prices. On the other hand, in addition to the declining trend of machinery prices due to technological innovations, the decline in prices of consumer goods arising from the past appreciation of the yen and the streamlining of distribution channels will exert downward pressure on prices. Thus, prices overall are expected to be stable or weak somewhat. In the financial market, the overnight call rate rose in response to the decision at the Monetary Policy Meeting held on 11 August to change the guideline for money market operations,3 and is generally moving around 0.25%. The amount of funds outstanding in the call money market has increased. Interest rates on term instruments increased towards the end of August, reflecting the termination of the zero interest rate policy, and has been mostly stable thereafter. The Japan premium remains negligible. Yields on long-term government bonds followed an upward trend from the second half of August and rose temporarily to 1.95-2.0%, but is recently moving in the range of 1.8-1.9%. The yield spread between private bonds (bank debentures and corporate bonds) and government bonds remains mostly unchanged as a whole. Stock prices rose from mid- to end-August but started to fall from late August and are recently moving around the level observed during mid-August. In the foreign exchange market, the yen-dollar exchange rate rose temporarily to around 109-110 yen in mid-August, but the yen appreciated thereafter. The yen is currently being traded in the range of 106-108 yen to the US dollar. With regard to corporate finance, private banks continue to be more active in extending loans mainly to blue-chip companies, while carefully evaluating the credit risks involved. On the other hand, the improvement in economic activities has not stimulated corporate demand for external funds, since firms’ cash flow is at a high level in parallel with recovery in profits. Moreover, firms continue to reduce their debts as part of their balance-sheet restructuring measures. As a result, credit demand in the private sector has continued to be basically stagnant. In view of this, the underlying tone of private banks’ lending remains sluggish. Recently, however, the expansion in the year-to-year decline seems to be ceasing. Issuance of corporate bonds and CPs has been steady. Money stock (M2 + CDs) grew slower in August compared with the previous month on a year-on-year basis. Recently, funding costs for firms are increasing, albeit gradually, due to the rise in money market rates after the termination of the zero interest rate policy. In this financial environment, there seem to be no substantial changes in the lending attitude of financial institutions and easing of corporate financing conditions. “The Bank of Japan will encourage the uncollateralized overnight call rate to move on average around 0.25%.”