The Bank of Japan sold dollars for the first time in five years yesterday, helping to push the yen up by 4.4 per cent as the markets reacted favourably to unexpected personal tax cuts.
Mr Ryutaru Hashimoto, Japan's Prime Minister, announced the emergency income tax cuts at a hastily-summoned press conference. The move, a sharp shift in policy, followed repeated assurances that personal taxes would not be reduced.
After Mr Hashimoto's announcement, the yen and stock market surged forward. However, some economists questioned how great the impact of the 2,000 billion yen (£53.5 billion) tax cuts would be on the moribund Japanese economy.
The Nikkei 225 average of leading shares, which had fallen in early trading to 15,985, surged more than 1,000 points. It closed 555 points up (3.48 per cent) at 16,541. The bond market was weaker on concerns the tax cuts and other measures would result in the issue of deficit-financing bonds.
The yield on the benchmark eight-year bond rose in Tokyo from 1.635 per cent to 1.69 per cent.
The yen closed at 127 yen to the dollar after analysts said the Bank of Japan had sold as much as $1.5 billion (£1 billion). Its aim was to warn speculators, who had expected the yen to fall as low as 150 yen, that the Japanese currency was not a one-way bet. The US has repeatedly expressed concern about the yen's weakness and the country's fast-growing trade surplus.
Mr Hashimoto brushed off suggestions he should resign because of his U-turn. "There were some who said I might be asked to take political responsibility for my decision, but that is a small matter compared to what I have to do now," he said. He insisted that in spite of the tax cuts, he remained committed to reducing the fiscal deficit.
President Clinton telephoned Mr Hashimoto to welcome the tax cuts as a "very constructive" measure.
Many analysts were more sceptical about the importance of the 2,000 billion yen tax cuts, pointing out that April's increase in sales tax had withdrawn 5,500 billion yen from the economy and that taxpayers had lost 2,000 billion yen of rebates. It was unclear whether the Japanese public would save their rebates or spend them.
Mr Cameron Umetsu, economist at UBS in Tokyo, estimated the tax cuts should add about 0.2 per cent to Gross Domestic Product next year. "Frankly that's a rounding error," he said.
Other measures included 2,000 billion yen of additional or accelerated public spending. Mr Hiroshi Mitsuzuka, Finance Minister, said the combination of personal and corporate tax cuts and higher public spending would be worth 5,000 billion yen - equivalent to 1 per cent of Japan's Gross Domestic Product.
Further measures could be announced today by the ruling Liberal Democratic party, which has yet to adopt the proposals formally.
