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 2009 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.
Meanwhile, the Bank of Japan policy board voted unanimously to retain interest rates at the low level and in a statement, it said: “Japan’s economy is picking up mainly due to various policy measures taken at home and abroad, although there is not yet sufficient momentum to support a self-sustaining recovery in domestic private demand.”
It added: “The bank recognises that it is a critical challenge for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability.”
The board added it expected Japan’s economy to contract by 2.5% for the current financial year, while growth of 1.3% for the 2010-2011 financial year has been estimated.
Meanwhile, not only is the economy battling to overcome deflation, there have been concerns about a strong yen.
While a strong yen is good news for the economy, it makes Japanese exports less competitive - but means imports are more affordable to Japanese consumers. Exports are a key to the economy‘s recovery.
In November, the yen reached a 14-year high against the US dollar and, at the time, there was speculation that the Government would take action.
However, Japan has not intervened on foreign exchange markets in six years, allowing the yen to find its own level.