Bank of Japan Introduces Negative Interest Rate
The Bank of Japan brought the thunder Friday, shocking investors and economists after it pushed a key interest rate into negative territory in its latest attempt to reinflate the country’s economy.
The Bank of Japan announced it had cut the rate on excess reserves to minus 0.1%, meaning institutions will have to pay the central bank for the privilege of parking reserves that exceed those required by regulators. The rate on most existing reserves, however, remains at 0.1%, while the rate for required reserves was cut to zero (see chart below). Unlike the single negative rate applied to deposits parked at the European Central Bank, the Japanese move is similar to tiered measures put in place by the Swiss National Bank, which punishes sight deposits, or commercial bank assets, of more than 320 billion Swiss francs ($312.5 billion) with a fee of 0.75%.
Why would it do that?
The move does speak to a certain degree of desperation.
There appear to be a number of reasons for the move. The most pressing is the fact that the Bank of Japan continues to struggle to achieve its goal of pushing inflation back up to 2%—considered a healthy level for most economies. The central bank on Friday further pushed out its timetable for achieving that goal to the first half of 2017.
Part and parcel of those concerns is the recent strength of the Japanese yen USDJPY, +1.95% While the currency has weakened sharply since late 2012 when the dollar fetched less than ¥80, it had found some renewed strength recently. Some analysts saw the ¥116 level as a possible line in the sand that might have spooked some policy makers and contributed to Friday’s decision.
Weak economic data and concerns that the bank’s ability to expand its already sizable asset-buying program amid liquidity concerns are also seen contributing to the move.
In the wake of the BoJ’s decision Friday, the yen plummeted to its lowest level in five weeks against the dollar to ¥121.00 compared with ¥118.84 late Thursday.
How do negative interest rates work?
Central banks use their deposit to influence how banks handle their reserves. In the case of negative rates, central banks want to dissuade lenders from parking cash with them. The hope is that they will use that money to lend to individuals and businesses, which in turn will spend the money and boost the economy and contribute to inflation.
It is also aiming to force investors to shift money out of bank accounts and into higher-yielding assets.
So this has been done elsewhere?
The European Central Bank in June 2014 was the first major central bank to venture into negative territory followed by the Swiss National Bank in December 2014. The Danish central bank has also employed negative rates to defend its currency’s peg to the euro, while Sweden’s rates are also in negative territory.
And former Federal Reserve chief Ben Bernanke has said that in the event of a serious downturn, negative interest rates are a tool that the U.S. central bank should consider.
Many economists see the Bank of Japan’s move as a testing of the waters. They expect the central bank to follow through with further cuts to the deposit rate, perhaps approaching the negative 0.75% rate in place in Switzerland.
What does it mean for other central banks?
The term “currency wars” is getting thrown around a lot this morning. The move has significantly raised expectations the European Central Bank will follow through in March with a further cut in its deposit rate and expansion of its own asset-buying program. European money market rates are pricing in a more than 100% likelihood of a 10-basis-point March cut by the ECB and an almost 100% likelihood of a cumulative 20-basis-point cut by year-end, noted analysts at Barclays.
Then there is the Fed. The move raises questions about the central bank’s ability to further raise interest rates in the face of a rising dollar, which highlights the widening divergence of global monetary policy.