Advanced Difficulties for Fukui

Last month, the Bank of Japan, Governor, Toshishiko Fukui wanted to raise the interest rates by 0.5 percent, from the exiting rate of 0.5 percent. Fukui who is retiring in March next year is driven by the danger of leaving the borrowing costs abnormally low which will fuel risky investments leading to asset bubbles.

The credit crunch that triggered a global sell-off of the stocks last month drove the yen to its highest level in more than a year as the market turmoil prompted investors to sell risky investments funded by the carry trades (investments funded by low interest loans in Japan).
However in the last few days Investors have started returning to carry trades that capture the difference in interest rates between the countries, mainly due to the fall in Yen which gives investor’s confidence to buy riskier assets using the carry trade. Investors sold Yen and bought the higher-yielding Australian and New Zealand dollars, which rose around 3 percent against the Japanese currency.
The Bank of Japan kept its benchmark rate at 0.5 percent, the lowest among major economies which acts as a support for Carry Trade, bringing Yen back under pressure.

The expectations of Bank of Japan raising interest rates are getting dampened due to the fall in core consumer prices. Japanese retail sales suffered highest decline in last two years due to the weakening of household spending. Now, if the interest rates are increased amidst this situation then the higher borrowing cost would further dampen the economy.
The main cause of concern is the fact that low interest rate shall initiate risky investments. Even if Japan raises its target rate to 1%, it would still leave borrowing cost among the worlds lowest. However the benefit of this move would be with Fukui’s successor who would have some leeway to loosen credit if necessary. With Zero interest rates, a central bank is equipped with only very limited policy tools. A central bank has to recover normal interest rates to be able to respond to the economy in a flexible manner.