Money market watchers say Bank of Japan Gov. Haruhiko Kuroda risks crippling the foundation of the nation’s financial system to achieve his inflation target.

The outstanding balance of interbank lending in the so-called call market tumbled 17 percent this year to 14.1 trillion yen ($137 billion) on April 11, the least since January 2003 when the central bank was conducting its first round of easing through bond purchases. The BOJ currently buys about 7 trillion yen of government bonds a month from financial companies, offers them 0.1 percent loans and buys treasury discount bills without any limit to boost money supply and keep borrowing costs low.

The decline in trading makes the money market vulnerable to shocks in times of crisis by increasing volatility, according to UBS AG. BOJ purchases have already eroded debt market trading, with 10-year government bonds untraded on April 14 for the first time in 13 years. Kuroda said the following day he won’t hesitate to adjust policy if needed as the central bank aims to boost inflation to 2 percent.

“The inflation target is the BOJ’s first priority, and the deteriorating functionality of the call market is unlikely to stop the BOJ,” said Izuru Kato, the president of Totan Research Co., a unit of money-market broker Tokyo Tanshi Co. “Call trading will remain stagnant.”

Banks have so much money on hand that they have no need to borrow in the call market, whose benchmark rate was the BOJ’s main policy tool until it switched to the monetary base last year. Financial companies held a record 134 trillion yen in their accounts at the BOJ as of April 16. The benchmark rate for overnight loans without collateral was at 0.07 percent on average this year, compared with the mean of 0.15 percent for the past decade.

Twenty-six of the 36 economists surveyed by Bloomberg News expect the BOJ to add to easing by July through expanding monthly government bond purchases, as well as buying more exchange-traded funds and real-estate investment trusts. Policy makers will release updated forecasts on inflation and economic growth after they next meet on April 30.

“The BOJ has no other choice but to add to stimulus at some point,” said Takafumi Yamawaki, the Tokyo-based chief rates strategist at JPMorgan Chase & Co., one of the 23 primary dealers obliged to participate in government debt auctions. “But I’m skeptical that they can come up with additional measures that have a big impact. I think it would end up being small-scale easing.” (Bloomberg)