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Financial Markets Report

-- Developments during the First Half of 2007 --

October 3, 2007
Bank of Japan
Financial Markets Department

Executive Summary

In the first half of 2007, the Bank of Japan decided to change the guideline for money market operations and encourage the target rate, the uncollateralized overnight call rate, to remain at around 0.5 percent from the previous 0.25 percent at the February Monetary Policy Meeting. This was the first policy interest rate rise since July 2006. Meanwhile, the complementary lending facility rate was set to 0.75 percent, expanding the spread between the basic loan rate of the complementary lending facility and the policy interest rate to 0.25 percent points from the previous 0.15 percent points. The increase in spread was based on the judgment that it would not impair money market operations, in light of improvements in the functioning of the money market. After the increases in rates, money market transactions picked up, and arbitrage transactions, among others, became more active, supporting smooth interest rate developments. The Japanese economy continued to expand in this financial environment.

With respect to global financial markets, from late February to early March, as market participants became more risk averse, stock prices declined in many economies, credit spreads widened somewhat, and the yen appreciated against other major currencies with the unwinding of speculative positions in the foreign exchange market. Background factors included the stock market decline in China, as well as the increase in uncertainty about the stability of the U.S. economy, especially the housing market, and financial markets. Subsequently, investor risk aversion subsided amidst market participants in many countries widely sharing the view that the global economy would continue to expand on the whole. Price developments in equity and credit markets also regained strength, underpinned by the positive outlook of market participants on firms' earnings, as well as brisk merger and acquisition activity. After May, a significant rise in long-term interest rates in the United States and Europe, reflecting a stronger outlook on the U.S. economy, led to some price adjustments in the equity and credit markets, but only to a small extent.

In Japan, prices in equity and credit markets continued to be firm overall, reflecting robust corporate performance among other factors. However, the rise in stock prices after the temporary decline in line with global equity market declines at the end of February and early March was moderate compared to those in the U.S. and European markets. Against the backdrop of a rise in interest rates in major economies in May and thereafter, long-term interest rates in Japan rose to temporarily exceed 1.95 percent. Short-term interest rates also rose. The yen weakened against other major currencies on the whole in the first half of 2007, against a background of relatively low interest rates, continued low volatility in the foreign exchange markets, and an increase in foreign asset investments by individual investors in Japan.


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Financial Markets Department, Bank of Japan
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