A few hours ago the Bank of Japan (BOJ) caused a few spikes on the charts, as well as the market players’ blood pressure, when it surprisingly announced its plans to adopt a negative benchmark interest rate. What’s the central bank up to?
What exactly did the BOJ say?
In a close 5-4 vote, BOJ Governor Kuroda and his gang have decided to cut their benchmark interest rates to -0.1% along with the decision to keep its annual asset purchases steady at 80 trillion JPY. This marks first interest rate adjustment since October 2010 and will add to the QQE program that the BOJ is already using. Meanwhile, growth forecasts were adjusted higher and inflation targets were nudged further.
The central bank pointed to falling oil prices, lack of developments in China’s economy, and volatility in global financial markets as reasons for stepping up its game. It also doesn’t hurt that the move could push inflation closer to its targets. Ultimately though, the BOJ is just worried that the economy won’t kick its “deflationary mindset” soon enough and delay the underlying inflation trend that it’s been working hard on.
Implementing negative interest rates isn’t exactly a “eureka!” moment, as it’s already being implemented by central banks of European regions like Denmark, Sweden, Switzerland, and more recently, the euro zone. The question is, will the “QQE with a negative interest rate” work for Japan?
QQE with a WHAT?!
The Quantitative and Qualitative Easing (QQE) With a Negative Interest Rate program is the BOJ’s new set of tools to stimulate activity in the economy. Think QQE PRO. Aside from being able to buy assets (quantitative) and targeting which assets to buy (qualitative), the BOJ is now charging financial institutions for parking its money in the central bank. Check out the neat chart provided by the BOJ!
Starting February 16, each financial institution’s account at the BOJ will be divided into three tiers and will incur different interest rates. While other central banks are charging negative interest rates to all deposits above the required reserves, the BOJ will only charge deposits that are not related to activities like sales of JGBs to the BOJ. Through this the BOJ is hoping to encourage activity among bank lenders instead of straight out charging them for parked money.
How did traders react to the news?
The yen was all over the charts during the Asian session. Though the Nikkei had hinted at the decision minutes before the actual release, it wasn’t until the BOJ had announced it that the yen fell sharply lower across the board. If you recall, analysts weren’t expecting changes from the BOJ. Heck, just last week Kuroda was telling everyone that a negative interest rate is NOT on the table and that further easing would likely come in the form of more asset purchases!
Major yen crosses like USD/JPY, EUR/JPY, and GBP/JPY spiked by hundreds of pips before calming down and seeing some intraday retracements. Japanese equities traders loved it though, and pushed Nikkei 2.8% higher at 17,518.30 by the end of the day, its highest close since January 13.
What’s next for the BOJ and the yen?
After the dust has settled around the BOJ’s surprise, analysts started speculating about the effectiveness of negative interest rates. For starters, those who are implementing negative interest rates aren’t exactly showing stellar records for it.
Then there’s the thought that the negative interest rates might just be a sign that the BOJ is running out of bullets. After all, you can only buy so much JGBs and REITs in the markets. If this is the case, then the BOJ might not have enough on its arsenal to achieve its 2.00% inflation targets.
For now it looks like the BOJ is still meaning business with its aggressive policy moves and it looks like dovish remarks and further yen losses are here to stay. The question is, how long will markets believe in the BOJ’s ability to reach its targets? More importantly, how will market players react if they don’t?