The Bank of Japan has trimmed interest rates back down to nearly zero and unleashed a spectacular salvo of measures to fix its broken credit markets, in the face of its sharpest and most destructive recessionary plunge in living memory.

In a move that highlights the severity of Japan’s woes, the central bank has effectively taken the country bank into the familiar territory of “quantitative easing” – the policy it previously adopted to drag the country out of its protracted slump.

Additional quantitative easing measures are likely to include colossal purchases of as much as Y20 trillion (pounds 145 billion) worth of shares from the bloated portfolios of the nation’s banking sector.

In what investors interpreted as an “all out” bid by Japan to match the aggressiveness of the US Federal Reserve, the central bank said that as well as stepping-up government bond purchases from the banks it would take the drastic step of beginning outright purchases of the commercial paper of corporate Japan – a move designed to thaw an acute funding freeze that is pushing thousands of companies to the brink of crisis.

Although many analysts viewed the rate cut as far less significant than the quantitative easing measures, the perceived delicacy of the situation was clear from the central bankers’ language.

Masaaki Shirakawa, the Governor of the BoJ said that the rate cut was “aimed at stimulating the economy,” but added that the rate had not been lowered to Japan’s traditional level of virtually zero “to avoid the short term money market from ceasing to function”.

The drop in rates, which haul Japanese central bank policy back to the days of the “lost decade” come as many of the country’s old demons have returned to haunt the world’s second biggest economy.

Senior economists at Nomura Securities warned on Friday that Japan would probably find itself living once again in the nightmare of deflation by the middle of next year.

The cut in the BoJ’s key policy rate from 0.3 per cent to just 0.10 per cent was made partly in response to the prolonged surge in the yen – a move that has annihilated the international competitiveness of Japanese exports and carved massive holes in the profitability of many of the country’s largest companies.

Before the rate cut was announced, Japanese awoke to alarming reports from Nagoya that the country’s most respected industrial icon, Toyota, would probably end fiscal 2008 with its first full-year loss since the company was founded 70 years ago.

Toyota’s cost-cutting and efficiency is legendary, and the prospect of seeing its first ever splash of red ink deals a crushing blow to overall confidence within Japan Inc.

The BoJ’s cut came along with yet more downgrades in the central bank’s outlook for the coming year – officials are now using the word “deteriorating” for the first time since Japan was in the grip of a banking crisis in 2002.

Although the rate decision mirrors this week’s move by the Fed, the direction of the quantitative easing measures point to what analysts said were more troubling signs from the corporate sector: the US authorities are expanding the central bank’s balance sheet to support the financial sector, while Japan is doing the same to support everything from electronic component makers to large restaurant chains.

After staring over the cliff-edge six years ago, Japanese financial institutions embarked on a period of painful deleveraging which only ended in 2005: in the current crisis, their funding issues are accordingly less dire than the corporate sector, which, said Societe Generale’s chief Asia Economist Glenn Maguire, “is being crunched by a complete inability to raise funds.”

Naomi Fink, Japan strategist at the Bank of Tokyo Mitsubishi UFJ, sounded a note of caution over the rate cuts, which effectively deprive Japanese households of around Y1.5 trillion in interest income.

Amid predictions that individual Japanese investors were set to become net buyers of their own market, money that appeared primed to flow into Japanese stocks for the first time in 18 years, may now not do so.

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