The Bank of Japan may be preparing to cut interest rates next month despite a succession crisis that has left the world’s second largest economy without a Governor of the central bank for the first time.

The expected rate cut, forecast today by the chief Japan economist at Goldman Sachs, sent a shudder through debt markets and triggered a buying frenzy in 10-year Japanese Government Bonds.

The moves follow action by the US Federal Reserve last night which ordered its second, aggressive three-quarter-point cut in American interest rates this year to stave off recession and shore up America’s fragile financial system.

The US central bank, led by its Chairman, Ben Bernanke, cut the key Fed Funds rate to just 2.25 per cent, the lowest since February 2005, in the latest drastic action to limit the growing toll from America’s housing slump and the global credit squeeze.

In Japan, the Goldman analyst, Tetsufmi Yamakawa, was among the first to argue that Japan was at high risk of recession and said that the BoJ might be preparing a contingency plan in which rates were cut back to zero in the event of serious market deterioration.

The force of the Goldman Sachs report was amplified by comments by Koji Tanami, the government’s nominee to be the next governor of the BoJ, who said that “downside risks to the economy are on the rise at home and abroad”.

Amid growing fears that Japan’s export-led economy will not weather the storms on Wall Street and the American housing scene, the market began to trade on expectations of a 25 basis point rate cut at the next monetary policy committee meeting in early April.

A quarter-point cut would bring Japanese rates down to just 0.25 per cent. Such a move would effectively end Japan’s tremulous and controversial bid to “normalise” its interest rates after their long stint at close to zero, which only ended in 2006.

It would also reverse the hard-fought legacy of Toshihiko Fukui, the current BoJ governor who steps down later today without an heir.

The BoJ governorship vacancy – the first since the Second World War – has been created by an unprecedented political stalemate which now threatens the stability of the entire political scene.

The massive political damage of the BoJ vacancy is expected to take a heavy toll on Prime Minister Yasuo Fukuda – Tokyo’s political heartland of Nagatacho was yesterday rife with speculation that the deeply unpopular prime minister and his entire cabinet may be forced to step down over the affair.

Prime Minister Fukuda has now had three nominees rejected in parliament and his six-month hold on power, said political analysts, is looking increasingly weak.

Despite his nomination by the ruling Liberal Democratic Party, however, Mr Tanami’s candidacy was today rejected in the Upper House of Japan’s parliament.

“Japanese politics will plunge into chaos now,” said Jiro Yamaguchi, a political analyst at Hokkaido University, “LDP members have already started to say that the Fukuda regime’s days are numbered.”

BoJ sources said that the most likely immediate solution to the succession problem would be that Masaaki Shirakawa - already endorsed by parliament as the next Deputy Goveror - takes temporary charge of the central bank until an acceptable candidate is found.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts