Previously, market participants had invariably forecasted an economic deterioration or a decline in interest rates, seeing no risk of interest rates rising in the year ahead. However, recent market developments implied that market participants had started to perceive such a risk.
With regard to overseas financial markets, many members said that, reflecting growing expectations that the FOMC would raise the target for the federal funds rate earlier than had been expected, interest rates rose and stock prices declined in many countries and regions, and the yield differentials between sovereign bonds of emerging economies and U.S. Treasuries expanded.
As for factors behind fluctuations in yields on JGBs, to which market participants paid close attention, it seemed that price developments had recently started to be regarded as a factor behind the rise in interest rates, in addition to developments in economic activity, stock prices, and overseas interest rates..
In relation to this, one member noted that, if the Bank tried to normalize monetary policy prematurely before achieving the price stability target, this could adversely affect economic activity through a rise in interest rates, and in turn reduce financial institutions' profits. The member then commented that financial system stability primarily should be ensured through prudential policy.
Even if interest rates rose substantially without any improvement in economic activity, the stability of Japan's financial system would basically be maintained. However, attention should be paid to the possibility that the impacts of an interest rate rise will exceed those estimated under the assumptions, depending on the speed and extent of the rise in interest rates and the factors behind it.
The member continued that, in these circumstances, a possible additional policy measure that could exert downward pressure on the yen would be to create expectations of vicious inflation in the market by, for example, underwriting JGBs, and in that case, interest rate increases and the yen's depreciation might occur simultaneously.
The ratio of financial institutions' loan-loss provisions for overall normal loans has remained at a historically low level that is below even that before the Lehman shock. However, in the event of negative shocks, such as an economic downturn or a rise in interest rates, firms-- especially middle-risk firms with low profitability and ability to repay their debt-- could be downgraded and credit costs could rise sharply.
However, we should take note that if irregularities in developed world economies or financial markets lead to worldwide economic slowdown, rising interest rates, or further appreciation of the U.S. dollar(i.e. currency depreciation in emerging nations), this might prompt a deleveraging trend in the emerging nations as companies move to reduce their excess debt, which could serve as an accelerator to amplify the instability in the global economy and financial markets.
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