BOJ INSIGHT: Negative Rates Show More in Toolbox for Infl Goal

By Hiroshi Inoue

TOKYO (MNI) – With negative interest rates taking effect Tuesday, Bank of Japan officials wish to keep expectations for 2% inflation alive by showing they have room to ease policy using more than just the asset buying program they began three years ago, but they also want to avoid volatility in the markets affected by their new tool.

The aggressive monetary easing since April 2013, which is largely based on purchases of government debt from banks, has failed to boost inflation to a stable 2% as it has been hit by an unexpectedly sharp drop in energy and commodity prices.

But the headwinds the BOJ is facing are not just caused by depressed crude oil prices, which reflect slow global demand and excess supply. What BOJ officials call the "deflationary mindset" among Japanese households and businesses has turned out to be much more stubborn than expected.

Keeping borrowing costs as low as possible has not been enough to entice consumers to spend and firms to invest in equipment. This means there is no clear pass-through route for any stimulative effects of the negative policy interest rate, either.

But BOJ officials cite other reasons for the new policy tool as well.

"We wanted to prevent market participants from thinking there is a limit to how much more the bank can do with monetary easing (through asset purchases)," said a person who is familiar with the BOJ’s latest policy decision at the Jan. 28-29 meeting.

Unstable global financial markets and depressed crude oil prices led the BOJ board to delay the estimated timing of achieving 2% inflation by six months for the third time in the past 10 months and adopt a potentially contradictory negative interest rate policy.

The vote on introducing the negative rate policy was five to four, with the usual skeptics of the stimulative effects of expanded easing voting against the chairman’s proposal.

The nine-member policymaking panel also decided by an 8 to 1 vote to leave the bank’s policy target unchanged, as largely expected. The BOJ will continue to increase its purchases of Japanese government bonds at an annual pace of about Y80 trillion.

Another person who is also familiar with BOJ thinking said if the BOJ had decided to increase its JGB buying in addition to adopting negative interest rates, the degree of monetary easing would have increased more than necessary to counter the current downside risk to growth and inflation.

Previously, BOJ officials were reluctant to apply a negative interest rate on excess reserves deposited by financial institutions at the central bank.

Discouraging banks from parking money at the BOJ by charging deposit fees would run counter to the idea of building up the total amount of money in circulation and cash reserves – the target of the quantitative and qualitative monetary easing.

So as a compromise, BOJ staff came up with a three-tier system for different kinds of reserves at the bank.

The BOJ will now charge financial institutions 0.1% interest if they deposit cash at the central bank beyond their legally required reserves, which is designed to encourage banks to lend more than parking money. The bank has been paying a 0.1% interest on excess reserves.

The BOJ said it "will cut the interest rate further into negative territory if judged as necessary."

The bank will continue applying the positive 0.1% interest to the "basic balance" of current account accumulated by lenders at the BOJ as a result of QQE while the zero rate remains on required reserves.

The BOJ has said that the initial amount of the "policy-rate balance," to which a negative interest rate of -0.1% will be applied, is about Y10 trillion at the start of the new policy Tuesday.

The amount of the "macro add-on balance" (with zero interest rate) will be increased by about Y20 trillion every three months and that of the policy-rate balance (-0.1% interest) will remain in the range of about Y10 trillion to Y30 trillion, the BOJ said.

This means when the policy-rate balance rises to about Y30 trillion, the overnight call loan rate – the interest financial institutions charge one another for short-term needs – will fall close to -0.1% from around zero now.

BOJ officials don’t think the overnight rate will fall to -0.1% immediately after Tuesday as some financial institutions need some time to adjust their systems to cope with negative-rate trading.

The BOJ board will decide on the frequency and the amount of the macro add-on balance (required reserves) based on developments in short-term money markets, reviewing them every three to six months, a third source said.

The balance of current account at the BOJ theoretically increases by Y6.7 trillion every month as the BOJ will be increasing the monetary base at an annual pace of Y80 trillion.

Meanwhile, BOJ officials see the recent drop in the 10-year Japanese government bond yield as "too rapid."

A day after the yield on 10-year JGBs hit a record low of -0.035% on Feb. 9, it rebounded to close at +0.010%. The 10-year yield has fluctuated in a range of 0.045% to 0.095% this week.

The recent rapid drop in the 10-year JGB yield is due to a combination of investor risk aversion and speculation that the BOJ may expand its negative rate policy.

If investors believe the BOJ’s easing policy is effective in stimulating economic activity and raising inflation, the 10-year bond yield will be pushed up by such outlook with a lag. But the 10-year yield is mainly set by bond market supply and demand conditions.

 

Ashley Joye Managing Partner T +44 (0)20 7422 2975 M +44 (0)7796 308 391 E ashley.joye@archr.com 49 Carnaby Street, London, W1F 9PY United Kingdom ARCHR.COM