By Toru Fujioka and Mayumi Otsuma Jan. 15 (Bloomberg) -- Japan’s central bank may see escalating political pressure to act against deflation as the government seeks to remove the threat of a recession relapse before a parliamentary election in July. Finance Minister Naoto Kan, in his second week in office after replacing Hirohisa Fujii, said yesterday that “there are still various policy measures that could be taken” by the Bank of Japan. He also praised the BOJ’s Dec. 1 introduction of a 10 trillion yen ($109 billion) loan program that came days after he expected more “monetary support” from the bank. He was economy minister at the time. “BOJ policy makers will feel more pressure to take action with Kan in the position,” said Hiromichi Shirakawa, a former central bank official who’s now chief economist at Credit Suisse Group AG in Tokyo. “Kan probably wants the central bank to give more stimulus to the economy as he’s much more political than Fujii and nervous about the government’s falling approval rating ahead of the upcoming election.” Among the bank’s options: Expand the credit program, increase its monthly purchases of government bonds, or specify a timeframe for keeping the benchmark interest rate near zero, economists said. The spark for action may be another surge in the yen that could undermine the export-led recovery. Sliding Popularity The Democratic Party of Japan’s popularity has slid since it came to power for the first time four months ago promising to end 20 years of economic stagnation. Prime Minister Yukio Hatoyama’s approval rating was at 56 percent this month, compared with 75 percent when he took office, the Yomiuri newspaper said on Jan. 11, without giving a margin of error. Kan said in his inaugural speech on Jan. 7 that he will work with the BOJ to keep the yen at an “appropriate” level, adding that he wants it to weaken “a bit more.” He said on Dec. 8 that the loan program “had considerable impact” in cheapening the currency and bolstering the stock market. The yen traded at 91.09 per dollar at 11:43 a.m. in Tokyo, about 7 percent weaker than the 14-year high of 84.83 reached on Nov. 27. The Nikkei 225 Stock Average has rallied 20 percent since then, and fell 0.17 percent in morning trading. “I want to make sure we communicate with each other thoroughly,” Kan said yesterday, referring to the central bank. “The government and Bank of Japan are cooperating very well.” Further Action Governor Masaaki Shirakawa and his colleagues may consider further action should the yen resume its advance and approach 85, said Hideo Kumano, a former Bank of Japan official. “The risk of a double-dip recession will surge if overseas economies deteriorate, which will probably make the currency market volatile and strengthen the yen,” said Kumano, chief economist of Dai-Ichi Life Research Institute in Tokyo. He said the policy board’s most likely option is to increase the size of the credit program and extend the period of the loans beyond three months. Alternatively, he added, the bank might increase its monthly purchases of government bonds from the current 1.8 trillion yen if Hatoyama decides to sell more of the securities to fund any further stimulus spending. Japan’s fiscal condition is deteriorating: The Finance Ministry forecasts bond sales will exceed taxes as the main source of funding in the year ending March. Hatoyama unveiled a record 92.3 trillion yen budget and a 7.2 trillion yen stimulus package last month. Benchmark Japanese bonds are headed for their first weekly gain in almost a month as deflation deepens. The yield on the 10-year bond fell 1.5 basis points to 1.32 percent, the lowest this week. Quantitative Easing The spending plans “will require the Bank of Japan to make a comprehensive re-entry into quantitative easing,” Glenn Maguire, chief Asia-Pacific economist at Societe Generale in Hong Kong, wrote in a note published Jan. 8. Morgan Stanley, Goldman Sachs Group Inc. and Pacific Investment Management Co. analysts also said this month the BOJ may step up its liquidity injections through purchases of government bonds to combat consumer-price declines. Another choice may be specifying a period for keeping the key rate at 0.1 percent, said Credit Suisse’s Shirakawa, who isn’t related to the governor. “Influencing expectations of market participants is probably the least costly step for the central bank,” he said. The bank edged toward such a pledge last month by saying it “does not tolerate a year-on-year rate of change in the consumer-price index equal to or below zero percent.” Its understanding of price stability is inflation of up to 2 percent. The range “can almost be taken as inflation target,” Keisuke Tsumura, one of Kan’s top two economic advisers, said in an interview yesterday. “We’re now at a stage where we can evaluate the impact of the bank’s policy.” Respect Autonomy Tsumura said Kan “will respect the bank’s autonomy,” a stance that economists including Shirakawa and Masaaki Kanno question. “Kan isn’t seeking a traditional relationship with the BOJ,” said Kanno, chief economist at JPMorgan Chase & Co. in Tokyo, who also used to work at the central bank. “It looks like he wants to create something different to keep them under control as far as the law allows and the bank can keep face.” The Bank of Japan is unlikely to bow to pressure if the government wants further monetary easing to help fund fiscal spending, said Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo. The central bank will only act “when it sees that there is a responsible and sustainable policy at the Ministry of Finance concerning the public debt,” Schulz said. “Kan needs to be expansionary, he needs to look responsible and he needs to get along well with the BOJ. If he does so, there is a very good chance that deflation finally will be over next year. That will be a major, major political achievement.”

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