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'BoJ may hike rates again by March 2007'
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July 14, 2006

Kiran Kowshik, currency economist at IDEAglobal says that the Bank of Japan, may keep rate hikes on hold for now and they might raise it again by March 2007.

He adds that the markets will look for an outlook on the overnight discount rates.

Excerpts from CNBC-TV18's exclusive interview with Kiran Kowshik:

Any surprises? What have you read in the language of what BoJ might do, going ahead?

To be honest, he's used most of the red trick, the Governor Fukui has already said these things in the past, that interest rates would be raised gradually depending on how the economy pans out.

All in all, this was expected so far. Two things to look for going forward would be, to what level they raise the overnight discount rate and the tone of Governor Fukui's comments, following his meeting at the press conference.

What is the significance of the discount rate?

Basically, the discount rate was instituted as an emergency measure by which financial institutions can borrow from BoJ. Financial institutions have a collateral, but of late, it is instituted to provide a ceiling to the overnight call rate. The spread between the overnight call rate and the discount rate has been very narrow and basically, the ceiling has lost its functionality. So investors are looking to the extent at which they raise it.

Some consensus is that they are going raise the overnight discount rate to 0.5 per cent, which would then in effect, leave a 25 basis point margin between the overnight call and the discount rate. They have done this prior to 2003 and this is a likely outcome. However, if they were to raise it to a lower level say supposedly 0.35-0.4, it could be taken as a dovish signal.

How do you read the language that the rates will be low for sometime and they will only raise it if required and if the economy is panning out as it has been forecast, what are they trying to tell the market?

For me, the red trick has been the same since they ended quantitative easing in March. If you look at the BoJ policy, board members like Mijono for instance, two weeks ago he was considered the most hawkish in the board and he emphasised that the most important thing for BoJ would be to make sure that the ending of zero interest rates is completely a separate issue from what follows afterwards. The Governor is going to reiterate this. This is all that is expected.

Would you say they are done for the year in terms of rate hikes?

Our central case scenario would be for them to be on hold and possibly raise the rates, probably in March 2007. One has seen this in the euro-yen strip, they become a lot more conservative in pricing future rate hikes. The risk remains; we will have to see what happens during the time of the October outlook report.

We will have to see what is happening in the capital expenditure, whether it is really strong, whether there are concerns about the over heating in the economy. But barring that, I would expect them to be on hold for now.

Now that it is a done deal, what sort of impact do you see on currencies like the dollar and Asian currencies like the rupee, in specific?

If you look at most of the moves, dollar-yen has broken above the 115 level in the past 2-3 days on concerns that the Governor can sound a lot less hawkish. A lot of what happens to this is primarily driven by what happens to the US. Next Wednesday, you have the core consumer price figures out of the US as well as Bernanke's testimony.

People would be looking to gauge as to how the Fed would move on with the monetary policy. Unless you get a closure on that, the dollar-yen is going to be elevated for now. If you want to play any yen strength, you would probably want to do so through the euro, probably a shot via euro-yen. Because the European markets are adequately pricing interest rates from the European Central Bank, going forward.

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