BOJ stuns markets with negative interest rates

Tokyo

IN A dramatic demonstration of its ability to surprise financial markets, the Bank of Japan on Friday introduced negative interest rates on deposits at the central bank as part of its push to get funds flowing through the sluggish economy and to ward off deflation.

The tactic worked - at least in the short term - sending the yen sharply lower (an indirect objective of the central bank's policy) and giving a welcome boost to Tokyo stock prices which have dropped sharply of late in sympathy with a slide in other markets.

Negative interest rates - designed to discourage banks from holding "excess reserves" with the central bank and to lend them out instead - were pioneered in Europe but BOJ governor Haruhiko Kuroda said as recently as this month that he did not feel these were appropriate for Japan.

Mr Kuroda is a "master of surprise", however, and the shock announcement provided a fillip to markets which had expected to see the BOJ simply announce "more of the same" in the form of expanded quantitative easing , or to take no action at all at this point.

The yen at one point plunged from 118.3 to the dollar in Tokyo before the announcement was made to 121.3 before gaining a little ground to 120.9 while the Nikkei 225 stock average jumped initially by over 3 per cent before ending the day with a gain of 2.8 per cent or 477 points to 17,518.3

The BOJ left unchanged for now its programme of buying 80 trillion yen (S$940 billion) annually of Japanese government bonds and other securities from the market as means to expand the monetary base - a strategy known as quantitative and qualitative easing or QQE.

At the same time the central bank put back further the date by which it hopes to achieve its 2 per cent annual inflation target from the latter half of fiscal 2016 to the first half of fiscal 2017, beginning in April next year.

Market opinion had been divided between those who expected no action from the BOJ on Friday and those who predicted that that it might raise its annual financial asset purchases to 100 trillion yen. In the event, it chose an entirely different option.

By charging banks for holding a portion of the huge amounts of reserves (some 220 trillion yen) which they hold at the central bank in excess of the legal requirement, the BOJ hopes to encourage them to put the funds to more active use in the economy.

The bank hopes to "push down the short end of the yield curve," sources close to the BOJ said. While this sounds to be only a technicality, it will in fact be a "powerful weapon" in influencing financial institutions' behaviour by impacting the "marginal cost of funds", the sources said.

The moves came amid concerns that the US economy may not be as strong as appeared when the US Federal Reserve raised rates last month, and at a time when emerging market stocks and currencies have been plunging.

"Japan's economy continues to recover moderately and the underlying price trend is improving steadily," Mr Kuroda said at a press conference after the Policy Board meeting. But there is a risk that further falls in oil prices, uncertainty over emerging economies and global market instability could hurt business confidence and delay the eradication of people's deflationary mindset.

"The BOJ decided to adopt negative interest rates to forestall such risks from materialising."

Recent market developments have convinced at least some members of the BOJ policy board that the "momentum" towards achieving its inflation target is being lost, and they decided to act now, sources said.

The Policy Board announced that it will charge 0.1 per cent interest on one of the three tiers of bank reserves. Asset purchases by the BOJ are responsible for the massive build up of these reserves while banks are reluctant to lend. The central bank is acting to reduce the attractiveness of this effective cash hoarding.

The radical move passed by only a slim 5-4 majority among the nine-member Policy Board, showing just how far Mr Kuroda is prepared to go out on a limb in pursuing unconventional monetary policy.

"I am very happy with governor Kuroda's leadership - adopting negative rates is exactly what was needed to re-assert the pro-active and pro-growth determination that underlies "Abenomics," veteran Japan analyst Jesper Koll told The Business Times.

Mr Kuroda's action "re-asserts that this is his BOJ, not the technocratic non-risk taking BOJ of the past," added Mr Koll, who is chief executive officer of investment group Wisdom Tree in Japan.

"The introduction of a negative interest on deposits with the BOJ by banks is quite a new experience in Japan and what reaction will be made by Japanese banks to this measure is unknown," Rei Masunaga, a former senior BOJ official told The Business Times. "I am rather doubtful about the effects of this new policy in Japan where the lending attitude of banks has always been positive, which is different from that of European banks. The introduction of negative interest rate may not stimulate further the lending attitude of banks."

The BOJ continues to insist that its policies are aimed at achieving a 2 per cent annual consumer price inflation target and at reversing the sticky deflationary mindset in Japan.

Official data released shortly before the end of the BOJ meeting showed that Japan's core consumer prices crept up by 0.1 per cent in December from a year earlier - far short of level targeted by the BOJ. At the same time household spending fell by a much sharper than feared 4.4 per cent in December.