By Mayumi Otsuma Dec. 1 (Bloomberg) -- The Bank of Japan said it will provide short-term loans to commercial banks amid pressure from Prime Minister Yukio Hatoyama’s administration to address falling prices and the yen’s surge to a 14-year high. The central bank will set aside 10 trillion yen ($115 billion) to make three-month loans at interest of 0.1 percent, it said today after the policy board held an emergency meeting in Tokyo. Eligible collateral will include Japanese government bonds, commercial paper and corporate bonds, the bank said. Calls on the central bank to do more to support an economy grappling with a stronger yen and deflation intensified today as the government called for action to complement a stimulus package it will release this week. Finance Minister Hirohisa Fujii stepped up his rhetoric by appealing to the merits of quantitative easing to spur growth. “What a disappointment,” said Daisuke Uno, chief strategist in Tokyo at Sumitomo Mitsui Banking Corp. in Tokyo. “Since they went out of their way to hold an emergency meeting, I thought they would at least boost purchases of long-term government bonds.” The yen pared losses, trading at 86.90 per dollar at 4:21 p.m. in Tokyo from 87.53 before the announcement. The Japanese currency had earlier weakened as much as 1.2 percent, the most since Oct. 15. On Nov. 27, it reached a 14-year high of 84.83, threatening Japan’s export-led recovery. Interest Rate Governor Masaaki Shirakawa and his board kept the key overnight lending rate at 0.1 percent by a unanimous vote. The decision to implement the lending program was also unopposed. The central bank also maintained its monthly purchases of government bonds at 1.8 trillion yen. Some economists had anticipated that the bank would increase the purchases to support the economy. “It is most effective at present to further spread the strong effect of monetary easing and encourage a further decline in longer-term interest rates in the money market through provision of ample longer-term funds at an extremely low interest rate,” the central bank said. The policy board maintained its view that the economy is “picking up,” adding that it will keep growing at a “moderate” pace until the middle of fiscal 2010. It cited volatile movements in the yen as a risk to the outlook. Australia Raises Japan’s monetary easing contrasts with Australia, which today raised interest rates for unprecedented third straight month to 3.75 percent as evidence mounts that the economy is strengthening. Deflation can undermine economic growth by making debt burdens heavier, eroding corporate profit margins and deterring capital investment and consumer spending. Japanese prices excluding fresh food slid 2.2 percent in October from a year earlier, a near record drop, and the government’s declaration of deflation on Nov. 20 was the first in more than three years. The government said today that it will compile a spending package this week to fight price declines and the stronger yen. Fujii indicated yesterday that the extra fiscal spending would exceed 2.7 trillion yen, or the amount of money frozen from the previous administration’s budget. Shirakawa and Hatoyama will meet “soon” to discuss quantitative easing policies in addition to falling prices and the stronger currency, Chief Cabinet Secretary Hirofumi Hirano said yesterday. Fighting Deflation “Hatoyama’s Cabinet seems to think that the BOJ isn’t playing a big enough role in fighting deflation,” said Susumu Kato, an economist in Tokyo at Calyon Securities. “The government may ask the BOJ to increase the amount of its government bond purchases” to around 2 trillion yen a month from 1.8 trillion yen, Kato said. The government may be looking for monetary policy measures to combat prices and the yen because it has the highest debt burden in the industrialized world, limiting the scope of fiscal policy. Fujii said today that that the government won’t rely on debt to pay for its spending package, while adding that bonds will be sold to plug a tax revenue shortfall. “The government wants the BOJ to do more because their budget is getting too tight to stimulate the economy,” said Mari Iwashita, chief market economist at Nikko Cordial Securities in Tokyo. “I don’t think BOJ action is warranted now, but eventually they may be forced to implement some measures.” Today’s decision came almost a year to the day after the bank began a program of helping companies get access to credit amid the global financial crisis. On Dec. 2, 2008, it decided to accept lower-grade corporate bonds as collateral for loans to banks. It has since been purchasing corporate debt from lenders in measures that it will let expire at the year’s end. A separate program of providing unlimited collateral- backed loans to banks is scheduled to end on March 31. Not all investors were disappointed with today’s decision. “On first glance, it looks like it’s less than some people in the market were anticipating but they could well have discussed other items for future implementation,” said John Vail, head of global strategy in Tokyo at Nikko Asset Management Co., which manages $93 billion in assets globally. To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

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