Facts
The Bank of Japan policy board today voted 5-4 to adopt negative interest rates as part of a new monetary policy framework entitled "Quantitative and Qualitative Monetary Easing with a Negative Interest Rate".Under the new policy, which will take effect 16 February 2016, the central bank will begin charging a negative interest rate of 0.1% on current accounts that financial institutions hold at the BoJ. Specifically, the BoJ will introduce a multiple-tier deposit rate system used by several central banks in Europe (ex. the Swiss National Bank). A positive deposit rate of 0.1% will apply to any existing BoJ current account balances (CAB). A zero rate will apply to required reserves held by banks. The negative interest rate (to be initially set at -0.1%) will be charged to any marginal increase in the financial institutions' current account balances in excess of these amounts.Alongside this new policy, the Bank of Japan will maintain its existing guidelines for asset purchases. Specifically, the policy board voted 8-1 to maintain its annual JGB purchase target at JPY80trn/year. Asset purchase targets for corporate bonds, commercial paper, ETFs, and J-REITs will remain unchanged at JPY2.2trn/year, 3.2trn/year, JPY3trn/year, and JPY90bn/year, respectively. The motion was adopted with a 8-1 vote.The BoJ specifically noted in its monetary policy statement and accompanying Q&A that it will not set a lower bound for yields on its JGB purchase, thereby implying that its can continue to meet its asset purchases while still adopting negative interest rates.The BoJ maintained its assessment that "Japan's economy has continued to recover moderately, with a virtuous cycle from income to spending operating in both the household and corporate sectors. It also stated that "the underlying trend in inflation has been rising steadily." However, the policy board noted that, amidst the backdrop of recent volatility in the financial markets, and uncertainties regarding developments in the emerging markets, particularly China, there is an "increasing risk that...a conversion in the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected."Finally, the BoJ noted that the new policy framework is designed to enable the Bank to pursue additional easing, combining negative interest rates with its existing quantitative easing programme. The central bank made it clear that it will "cut the interest rate further into negative territory if judged necessary." For details of the decision and supplementary documents, please refer to the following links.
29 January 2016, Bank of Japan, Introduction of "Quantitative and Qualitative Monetary Easing with a Negative Interest Rate": https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf
29 January 2016, Bank of Japan, Key Points of Today's Policy Decisions: https://www.boj.or.jp/en/announcements/release_2016/k160129b.pdf
Implications
Economics
The adoption of negative interest rates (NIRP) by the Bank of Japan signals a big change in the focus of the central bank's easing methods, away from a focus on quantitative balance sheet expansion back to interest rates: though the BoJ has said that it will continue with its asset purchases and that NIRP is intended to complement the existing QQME programme, this is nothing short of an admission, by the central bank, of the declining effectiveness of large-scale bond buying. This is an argument that we have been making for some time (see: Bank of Japan: Beyond QE: Policy after "shock and awe," 10 November 2015). However, we had not been expecting a transition to a rates-based policy framework until FY16, at the earliest. The consensus also saw rate cuts as a low probability scenario, especially at this timing. According to the 27 January Bloomberg policy survey, only 6 out of 42 analysts expected additional easing at today's meeting with measures mostly focusing on the size of the bank's asset purchase targets.
Governor Kuroda had repeatedly stressed that the central bank was not considering cutting the deposit rate since the existing 10bps IOER facilitated the smooth purchases of JGBs by the BoJ under its quantitative easing framework. In Q&A accompanying today's policy decision, the central bank specifically dismissed concerns that negative interest rates would make it difficult for the BoJ to continue purchasing JGBs, explaining that the Bank will simply offer a higher price for bonds in order to compensate financial institutes for the loss stemming from punitive deposit rates. As is the case in Europe, the result is that the combination of QE and NIRP will serve to push bond prices up (and interest rates down) further along the entire yield curve. The Bank also stated that it is prepared to take additional easing measures in terms of all three dimensions--quantity (i.e. the size of its asset purchases), quality (i.e. the composition of risk in its asset purchases), and now the interest rate. Despite these assurances, we sense that the central bank is no longer focused on the quantitative elements of its easing programme. Any additional easing will likely be delivered via further rate cuts.
The accompanying statement makes it clear that downside risks to inflation prompted the Bank of Japan to act today. The weak tone of December data--released this morning--likely sealed the deal for Governor Kuroda and helped deliver a majority vote in favour of easing: December IP, CPI, and household spending all surprised on the downside (see Japan: CPI (Dec): Losing momentum, 29 January 2016). Up until this point, the central bank has looked through the weakness in growth, arguing that a resilient non-manufacturing sector and tight labour markets underpinned underlying inflation. But the central bank likely judged that the costs of inaction were rising. Indeed, the policy board sounds much more pessimistic on the outlook for inflation and prices in its latest policy statement, citing concerns about the volatility in financial markets, further declines in crude oil prices, and uncertainty over emerging markets and commodity-exporting economies. Notably, it specifically singled out concerns over developments in the Chinese economy.
The latest flurry of measures allows the central bank to argue that it is doing everything it can to combat disinflationary pressures. However, with interest rates already at record lows, we do not expect these measures to have a significant impact on the real economy, or inflation. As such, we think there are still strong downside risks to the board's inflation forecasts. Pressure for additional easing is unlikely to go away.
Governor Kuroda is expected to provide further background on today's policy decision in his regular post-MPM press conference scheduled for 3:30pm local time.
- Izumi Devalier, Japan Economist
FX
In the initial aftermath of the BoJ's announcement USD-JPY quickly rose to a high of 121.42 (Bloomberg price) but this did not last long. Some will argue the BoJ's actions were aimed at offsetting JPY strength. Indeed, the speed of its strength since the start of the year had provoked policymakers to step up their jaw-boning, with one official recently stating they are "closely watching" the JPY.
However, questions will soon be asked about how long JPY weakness can persist. When the BoJ last surprised the market by easing policy on 31 October 2014 USD-JPY quickly rose from 108 to 122 over the following few weeks. However, the current market environment is very different today and the focus on the RMB could mean BoJ easing may not be as successful in weakening the JPY. The coming daily fixing patterns by USD-CNY will be particularly important in gauging whether China will 'respond' to the BoJ's decision today.
For Asian FX, the implications of the BoJ's easing will be most pronounced for the KRW and TWD. Given the export similarities across these economies, there will initially be concerns that BoJ easing has the potential to hamper already struggling exports in Korea and Taiwan. As such, we could see FX policy for KRW and TWD become focused on engineering currency weakness in order to maintain export competitiveness. Additionally, Korea and Taiwan have strong economic linkages with China and therefore the KRW and TWD would be susceptible to further depreciation pressures if the RMB weakens following the BoJ's policy easing. The North Asian currency bloc is increasingly facing conflicting forces that runs the risk of giving global currency war fears new impetus.
- Paul Mackel, Head of Global EM FX Strategy
- Alastair Pinder, Strategist