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Monday January 17, 2:36 am Eastern Time

BOJ moves to normalise surplus,policy seen on hold

By Kanta Watanabe

TOKYO, Jan 17 (Reuters) - The Bank of Japan (BOJ) on Monday nearly completed absorbing excess liquidity it injected late last year to quell computer bug concerns, dashing speculation it might leave the daily fund surplus at a higher level to weaken the yen.

The BOJ left the money market with a projected net surplus of 1.9 trillion yen ($18.1 billion) after its regular 0020 GMT operation on Monday, down from a surplus of 6.9 trillion yen on Friday.

It later drained another 500 billion yen, bringing the surplus down to 1.4 trillion yen, close to the 1.0 trillion yen level seen before it started injecting extra liquidity.

To alleviate Y2K-related concerns, the BOJ had boosted the net surplus level to as high as 24.4 trillion yen by January 4.

Some players had speculated that the BOJ might keep the surplus above the 1.0 trillion yen level to help drive the strong yen lower, but BOJ watchers said that was reading too much into the seemingly slow pace of the BOJ's fund drainage.

``The BOJ has always said they don't believe that there is any fundamental link between levels of excess reserves under the zero interest rate policy and foreign exchange levels,'' said James Malcolm, an economist at J.P. Morgan Securities Asia.

``We did not believe at all that the high levels of excess reserves indicated any change in monetary policy. So we are not surprised that they are now very close to pre-calendar-year-end levels.''

TIGHTENING STILL MONTHS AWAY

As expected, the BOJ's Policy Board agreed to keep its monetary policy unchanged at its first meeting of the year on Monday and analysts said the next BOJ policy move was most likely to be a tightening as the economy picks up after years of stagnation.

Financial markets have been jittery about a possible tightening since BOJ Governor Masaru Hayami told Japanese media earlier this month he hoped to end the BOJ's zero interest rate policy sooner rather than later. Jun Ishii, chief market economist at Tokyo-Mitsubishi Securities, said: ``The BOJ should want to end the zero interest policy as early as possible, as the bank sees it as an emergency step against a deflationary spiral.'' The bank was also worried by memories of a prolonged period of loose monetary policy in the late 1980s which invited the collapse of an asset price bubble and the start of Japan's worst post-war recession, Ishii said.

But most analysts said any tightening was still months away as the economy is still too fragile to withstand shocks, particularly a further appreciation of the yen.

Masuhisa Kobayashi, fixed income strategist at Merrill Lynch Japan, said: ``The BOJ is likely to keep the daily fund surplus at one trillion yen or above for a while, as cutting it below one trillion yen would invite a stronger yen.''

POLITICAL PRESSURES ON BOJ MAY INTENSIFY

Political pressure on the BOJ to help nurture the recovery with loose policy is also expected to build ahead of a general election which must be held by October this year, making tightening an unlikely scenario.

J.P. Morgan's Malcolm said it also made sense for the BOJ to wait until after the elections to reduce market volatility before it finally raises rates.

``It's possible that the overnight rate will go back up to 25 basis points in the fourth quarter this year, but our best guess is for the first quarter next year,'' Malcolm said.

The BOJ last eased policy in February 1999 when it decided to guide the overnight call rate to an initial 0.15 percent from 0.25 percent before pushing it down ``as low as possible.''

($ equals 105 yen)

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-- Linkmeister (link@librarian.edu), January 18, 2000.