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Semiannual Report on Currency and Monetary Control (Summary)
Second Half of Fiscal 2005

The semiannual report, which included this summary, was submitted to the Diet in June 2006.

Bank of Japan

Economic Developments

1. Japan's economy continued to recover steadily in the second half of fiscal 2005 (October 2005-March 2006).

Exports continued to increase against the background of the expansion of overseas economies, and the uptrend in industrial production became evident. Business fixed investment continued to increase against the background of high corporate profits. Household income continued rising moderately, reflecting improvements in employment and wages. Under these circumstances, private consumption was more solid. Housing investment showed some strength. Meanwhile, public investment was on a downtrend.

2. The year-on-year rate of increase in domestic corporate goods prices rose gradually, reflecting the rise in commodity prices at home and abroad and the improvement in supply and demand conditions. The year-on-year rate of change in the consumer price index (CPI; excluding fresh food) became positive in November 2005 and remained positive thereafter.

Financial Developments

3. In the money market, the uncollateralized overnight call rate was at around zero percent generally throughout the second half of fiscal 2005. Interest rates on term instruments were stable at low levels until early February 2006, but rose somewhat thereafter, factoring in a possible termination of the quantitative easing policy.

Long-term interest rates rose, albeit with some fluctuations, reflecting a further improvement in business sentiment, rises in long-term interest rates overseas, for example in the United States, and emergence of various views regarding the future conduct of monetary policy. They were at the 1.75-1.80 percent level at the end of fiscal 2005.

The Nikkei 225 Stock Average rose substantially from the beginning of the second half of fiscal 2005 until mid-January 2006, reflecting stronger-than-expected Japanese economic indicators and announcements of business performance by Japanese firms. Although it declined in mid-January, it continued to be on a rising trend on the whole, and passed the 17,000 yen level at the end of fiscal 2005.

The yen was on a depreciating trend against the U.S. dollar from the beginning of the second half of fiscal 2005 partly against the background of prospects of a wider interest rate differential between Japan and the United States, declining to the 121-122 yen level through early December 2005. Thereafter it generally moved in the 114-119 yen range in a situation where there were various speculations regarding the future conduct of monetary policy in Japan and the United States.

4. The year-on-year rate of increase in the amount outstanding of lending by private banks (after adjustment for special items) continued to accelerate, and the amount outstanding of CP and corporate bonds issued was above the previous year's level. The lending attitude of private banks became more accommodative. The decline in credit demand in the private sector was coming to a halt because business outlays such as business fixed investment continued to increase in a situation where the economy continued to recover steadily.

5. The year-on-year rate of change in the monetary base (currency in circulation plus current accounts at the Bank) had been positive at the 1.0-3.0 percent level until February 2006, albeit with some fluctuations, but turned negative in March. The ratio of the monetary base to nominal GDP remained at an extremely high level.

The year-on-year growth rate of the money stock (M2+CDs) moved approximately in the range of 1.5 percent to 2.0 percent.

Monetary Policy Meetings (MPMs)

6. Seven MPMs were held in the second half of fiscal 2005.

In the second half of fiscal 2005, members of the Policy Board revised their assessment from"Japan's economy continues to recover" to"Japan's economy continues to recover steadily" in January 2006, mainly because it became clearer that a virtuous cycle of production, income, and expenditure was operating.

Members maintained the same assessment at all MPMs during the second half of fiscal 2005 that domestic corporate goods prices had continued to increase, mainly reflecting the rise in crude oil prices, and were expected to continue increasing. They confirmed at the MPMs in January and February that the year-on-year rate of change in the CPI (excluding fresh food) had been slightly positive. At the MPM in March, they confirmed that the year-on-year rate of change in the CPI had recorded a larger increase, and projected that it would follow a positive trend, albeit with some fluctuations.

7. With regard to the conduct of monetary policy, given the above economic and financial developments, members decided to maintain the guideline for money market operations aiming at an outstanding balance of current accounts at the Bank of around 30 to 35 trillion yen at MPMs during October 2005-February 2006, based on the commitment that the Bank would maintain the quantitative easing policy until the year-on-year change in the CPI (excluding fresh food, on a nationwide basis) registered zero percent or higher on a sustainable basis.

At the MPM in March, members judged that, based on the above analysis of economic activity and prices, the condition laid out in the commitment was fulfilled. They decided to change the operating target of money market operations from the outstanding balance of current accounts to the uncollateralized overnight call rate, and to set the guideline for money market operations as follows:"The Bank of Japan will encourage the uncollateralized overnight call rate to remain at effectively zero percent." In addition, they decided to introduce a new framework for the conduct of monetary policy, as well as to review the Bank's thinking on price stability.

The Bank's Balance Sheet

8. As of the end of March 2006, the Bank's balance sheet had decreased by 3.8 percent from the previous year to 144.9 trillion yen.