BOJ FOCUS-New BOJ steps may ease strains, but no panacea

* BOJ's new scheme may help ease funding strains

* New scheme based on overnight call rate

* Eyes on BOJ's overall fund injection stance

By Masayuki Kitano

TOKYO, Dec 5 (Reuters) - The Bank of Japan's new funding scheme, due to start next month, is likely to help ease upward pressure on money market rates and commercial paper rates, but much depends on how the BOJ employs its existing tools.

Since the credit market turmoil made investors wary of taking on risks, demand for corporate bonds and commercial paper has weakened. This has made it more difficult and expensive for companies to raise funds through the markets.

Longer-end money market rates have been rising because of the market strain as well as seasonal demand for funds as the end of the year approaches.

Three-month euroyen TIBOR, Japan's benchmark for interbank lending, dipped right after the BOJ cut its overnight call rate target to 0.30 percent in late October, but has since edged up and is now higher than before the cut.

On Friday, three-month euroyen TIBOR rose to 0.89385 percent ZTIJPY3MD=. It was around 0.88 percent in late October before the BOJ's rate cut.

To provide relief, the BOJ plans to supply funds to financial institutions from January past Japan's fiscal year-end in March. As in its regular money market operations, the central bank will accept various types of corporate debt as collateral, including corporate bonds and commercial paper.

The difference to those regular operations is that under the new scheme, the BOJ will lend funds of up to three months at rates based on its overnight call rate target JPONMU=.

The BOJ has also said it will start accepting triple-B-rated corporate bonds and loans on deeds as collateral in funding operations starting Dec. 9. It previously only accepted debt rated single-A or above. Both measures will remain in place until April 2009.

"It will probably help stabilise money market interest rates that cover the fiscal year-end period, especially commercial paper rates," said Shinsuke Kanabu, joint general manager for the management planning division at money broker Central Tanshi.

The new scheme is similar to measures adopted a decade ago, when Japan was in the midst of a financial crisis accompanied by a credit crunch.

However, the BOJ's decision to lend at the overnight call rate rather than higher rates such as the Lombard rate is new. When the BOJ undertook a simiar emergency operation in 1998, it provided the funds at 0.5 percent, while the overnight call rate target at the time was 0.25 percent.

Now, the BOJ will charge financial institutions the average of the overnight call rate target over the period of the funding. The Lombard rate currently stands at 0.50 percent.

"This is likely to trigger a fall, through various channels, of term money market rates, which have not declined up to now," said Tsutomu Hattori, chief manager at the ALM & Treasury department at the Bank of Tokyo-Mitsubishi UFJ.

The steps will not fully alleviate the strains on corporate financing that pushed the average yield on newly-issued three-month commercial paper to 1.18 percent in October, the highest since 1.35 percent in January 1998 and up from 0.86 percent in September, according to BOJ data.

The temporary nature of the measures could also temper the effect they have on broader corporate financing.

"The impact on long-term lending or corporate bond issuance will probably turn out to be limited," said Kanabu at Central Tanshi.

In addition, investors are likely remain cautious about taking on credit risks, as are financial institutions, which have been hit by the sharp fall in Tokyo share prices this year.

The behaviour of longer-term money market rates around the end of the calendar year and fiscal year will hinge on how actively the BOJ chooses to inject funds, money market traders said.

BOJ Governor Masaaki Shirakawa said on Tuesday the BOJ expects that it can provide about 3 trillion yen ($32.44 billion) in funds under the new scheme.

Traders said the impact of the scheme could be diluted if it is simply used in place of existing money market operations.

"The key is the amount. The new scheme will happen in January, but if the amount of operations with around two-month maturities that are now being conducted were reduced in their place, then there would not be any meaning to it," said a money trader for a European bank.

(Editing by Sophie Hardach)