The Bank of Japan just stunned global markets by announcing negative interest rates
REUTERS/Eddie KeoghA Japan fan poses before Scotland vs. Japan Rugby World Cup game on September 23, 2015.
The Bank of Japan (BOJ) has just stunned financial markets, taking official interest rates into negative territory.
Voting 5-4 in favor of the measure, the bank announced that it will charge an interest rate of -0.1% for excess reserves parked at the bank by financial institutions.
The basic idea behind taking interest rates into negative territory is to encourage lending from banks who are now charged a small amount to keep cash at the Bank of Japan, which in theory will increase economic activity.
The BoJ also stated that it will be willing to cut interest rates further if necessary.
Akin to the same policy implemented by the Swiss National Bank, the BOJ announced that it will adopt a tiered system for interest rates, stating that outstanding balances of each financial institution at the Bank will be divided into three tiers, to each of which a positive interest rate, a zero interest rate, or a negative interest rate will be applied.
The BoJ has used the chart below to demonstrate how the tiered system will work.
Bank of Japan
“Although a negative interest rate is not applied to the total outstanding balances of current accounts, costs incurred with an increase in the current account balance brought by a new transaction will be -0.1% if it is applied to a marginal increase in the current account balance,” the BOJ wrote.
Sean Callow, currency strategist at Westpac, explains how the process will work:
From 16 Feb, the BoJ will apply a rate of -0.1% on certain deposits and says this rate could be cut again if necessary. The details show that this is a less punitive measure than at first glance, with concern over “financial institutions’ earnings”. Other central banks have negative rates on the balances of banks’ deposits over the prudentially required reserves. The BoJ is adding another layer, protecting the additional reserves created by banks’ sales of JGBs to the BoJ under QQE so far. These reserves will still attract a +0.1% rate. Reserves for prudential reasons and selected other programs earn zero. So it's only balances above these that will be penalized with the -0.1% rate, which in practice will mostly be BoJ asset purchases beyond 16 Feb.
The BoJ cited recent volatility in financial markets, particularly toward the outlook for the Chinese economy, as one of the catalysts behind its decision.
“There is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected, said the bank.
“To preempt the manifestation of this risk and to maintain momentum towards achieving the price stability target of 2%, the bank decided to introduce QQE with a negative interest rate.”
Outside of interest rates, policy was left unchanged.
As they have done since October 2014, the BOJ kept its QQE program unchanged, maintaining an annual expansion in the nation’s monetary base at around 80 trillion yen.
In line with the sentiment expressed in the bank’s policy statement, the BOJ’s median core CPI forecasts were also lowered for the 2016-2017 fiscal year.
Excluding volatile items, the bank now expects inflation to average 0.8%, down from 1.4% seen in October last year. Forecasts for 2015-2016 and 2017-2018 were left unchanged at 0.1% and 1.8% respectively.
The BoJ now expects to meet its 2% inflation target around the first half of fiscal year 2017-2018.
In response to the expected positive impact that ultra-easy monetary policy will deliver, the BOJ increased its 2016-2017 median GDP forecast from 1.4% to 1.5%. That for 2017-2018 was left unchanged at 0.3%
The BoJ's tweak to interest rates, entirely unexpected by markets, created some wild movements across Japanese financial markets.
Post the announcement, the Nikkei 2255 traded in a 871-point range, rising more than 3% only to plunge by more than 1% soon after. Eventually the index closed the session at 17,518.30, up 2.80%.
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The USD/JPY had a similar reaction to the Nikkei, rallying as high as 121.33 immediately after the BOJ announcement before retracing. It’s currently trading at 120.45, up 1.38% for the session.
Benchmark Japanese 10-year JGB yields also plummeted, falling at one point to 0.12%, the lowest level on record. Five-year JGB yields also went below 0% for the first time ever.
While markets have responded well to Friday’s announcement, just as they did to hints from the ECB earlier this month that they too will likely ease policy further in the months ahead, the weakening in both the yen and euro will place upward pressure on the US dollar and, as a consequence, the Chinese renminbi.
At a time when both nations' trade-exposed sectors are struggling, additional monetary easing from the BOJ, and likely the ECB, will add to already strong economic headwinds buffering the US and Chinese economies at present.
Whether they will be able to sustain this additional pressure remains debatable, and will add to risks that they too will take action to stimulate economic growth within their own economies.
Read the original article on Business Insider Australia. Copyright 2016.
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