The Bank of Japan loosened monetary policy on Wednesday in a split vote that suggested the central bank would struggle in the future to meet government demands for easier monetary conditions.
The government has prodded the BOJ for weeks to ease policy, a tactic analysts say is aimed at preventing a rise in the yen from derailing an export-driven recovery and deepening deflation.
The BOJ doubled to 20 trillion yen ($221 billion) the funds available to banks for three-month loans at the policy rate of 0.1 percent. The outcome was in line with expectations.
Governor Masaaki Shirakawa said the decision was aimed at ensuring the economy recovers from the global downturn and pulls out of deflation, but analysts said it was a modest easing of policy that would have only a limited impact.
Resistance to the decision by two of the seven board members -- Tadao Noda and Miyako Suda -- suggested the consensus-seeking central bank might take longer to shift policy in the future, when analysts expect it to come under renewed pressure from the government for further action.
The split vote leaves an impression that it will become more difficult to get a consensus from board members for additional easing measures, said Hideo Kumano, chief economist at Dai-Ichi Life Research Institute in Tokyo.
As widely expected, the BOJ also left its policy rate unchanged at 0.1 percent.
The yen initially jumped before giving back gains as Japanese investors sold into the move. But traders expect the yen to edge higher into Japan's business year-end on March 31 as hedge funds test policymakers' willingness to stomach a stronger currency and Japanese companies repatriate funds from overseas.
Three-month euroyen futures hit a two-week low, retreating along with Japanese government bonds. Euroyen futures, which are based on benchmark Tokyo interbank lending rates, had soared in December on reports of the BOJ's emergency meeting that led to the three-month funding operation.
The BOJ needed to expand the duration of the operation to six months if it wanted to bring down term rates, said Frederic Neumann, senior Asia economist at HSBC in Hong Kong.
There isn't much uptake in the three-month operation. Fundamentally, the BOJ hasn't loosened the reins.
ALONE IN EASING
The BOJ is virtually alone in easing monetary policy among major central banks, although most other G7 authorities are showing little inclination to tighten policy either.
The Federal Reserve renewed its pledge on Tuesday to keep U.S. interest rates near zero for an extended period even as it sounded more upbeat about jobs.
The Japanese government's room to inject fresh life into the economy is limited by a public debt of close to 200 percent of GDP. But falling ratings in opinion polls are raising the heat on the government for results ahead of an upper house election expected in July.
Equally, the BOJ has long argued it has limited ability to lift the economy when its policy rate is already so low.
The latest decision is no exception, analysts said, partly because lending is falling anyhow. Spare economic capacity means there is little loan demand for funds to invest in businesses.
Short-term rates have fallen to as low as they can go, so there is little impact on interest rates. And as the BOJ has been saying, even if they expand the scale of the funding operation, bank lending isn't growing, so the direct impact on the economy will be small, said Naomi Hasegawa, senior fixed-income strategist at Mitsubishi UFJ Securities in Tokyo.
Sources had told Reuters there was not necessarily a consensus in the board on the need for easing now, and remarks by Noda and Suda had shown they had doubts about easing policy.
Suda has repeatedly warned that keeping policy loose for too long could backfire, while Noda had said he saw no need to change policy.
Still, analysts said they expected the government to maintain its pressure on the central bank to keep loosening monetary policy as a way to keep yen rises in check.
That view was underscored by Finance Minister Naoto Kan, who said he will consider setting up a regular forum for talks with the BOJ, an idea previously floated by the government but which did not materialize.
Considering that the BOJ did the least, the market will start factoring in further monetary measures by the central bank in the future, said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo.
The government is expected to continue pressuring the BOJ to take future measures. I don't think the government will be satisfied by the BOJ's measures.
If government pressure escalates, the Bank of Japan may further expand the size of the funding operation, or extend the duration of loans beyond three months, analysts say.
But if bond yields surge on worries about Japan's fiscal state, it may be nudged into taking more aggressive steps such as buying more government bonds, they say.
The yen hit a 14-year high of 84.82 per dollar in late November and trended lower after the December BOJ meeting reduced three-month lending rates.
But worryingly for the government it rose again earlier this month to a three-month high against the dollar, and data shows speculators have built positions betting on further rises.
Low global interest rates means that currencies other than the yen are being used to fund carry trades and the euro's broad fall over Europe's debt woes has also boosted the yen.
Reducing yen borrowing costs could be one way to reduce the strength of the currency. Indeed, the BOJ said its decision on Wednesday was aimed at encouraging a fall in longer-term interest rates.
(Additional reporting by Rie Ishiguro; editing by Neil Fullick and Michael Watson)