Bank of Japan Shocks Markets
Amidst the hysteria accompanying global market uncertainties, Japan’s announcement of a new monetary weapon is yet another surprise markets have to absorb. On Friday, the Bank of Japan (BOJ) unveiled its plan to lower interest rates to a negative -0.1% on excess bank reserves. The move comes after the BOJ failed to accelerate inflation to the target level of 2% following years of sizable government bond purchases (QE). The BOJ’s latest policy affirms its doggedness at countering deflation at any cost.
The unconventionality of Japan’s latest stimulus measure, which BOJ has titled “Quantitative and Qualitative Monetary Easing with a Negative Interest Rate,” is unique given the way they’ve structured interest rates. Bank reserves held with BOJ have now assumed a layered or “3-tier” structure: the interest rate on the existing reserves (basic balance) remains unaltered at +0.1%; the newly added required reserves (macro-add on balance) will earn 0%; and the reserves in excess of the aforementioned tiers would end up with -0.1% interest.
So, essentially the policy penalizes banks for keeping reserves in excess of the minimum requirements of the BOJ. This means banks will be dissuaded from holding reserves thereby, theoretically, freeing up more cash for them to lend. More lending means expanded credit which has an ultimate goal of stimulating consumer spending and business investment.
Japan has long been afflicted with bouts of deflation with which it still continues to struggle: its ¥80 trillion ($660 billion) worth of QE bond purchases in 2014 notwithstanding, deflationary tendencies persist. In December 2015, Japan experienced a meager year-on-year core inflation of 0.8%, down from 0.9% in November. Furthermore, global weakness including a slowdown in China, declining commodities, and plunging oil prices have contributed to worsening business sentiments in Japan particularly in its export sector. It’s a difficult time to be going after 2% inflation.
Nevertheless, the BOJ continues doing just about everything it can to boost aggregate demand. By setting negative rates on excess reserves, BOJ hopes to create more favorable terms for borrowing in order to boost investments and consumption spending that are expected to push up prices. Also, lower returns on depositors’ money at banks could act as a disincentive for savers which should propel them to park money in higher-yielding assets (in turn, leading to the propping up of asset prices).
Moreover, injecting liquidity while the U.S. follows monetary tightening should weigh on Japan’s currency – the yen has already declined against US dollar by 1.9% to 121.07 yen in response to the BOJ’s announcement. A weaker yen should boost exports from Japan, providing yet another channel for extricating the economy from deflationary pressures.
Bottom Line for Investors The BOJ’s stance in maintaining negative interest rates should not necessarily augur negatively for the U.S. markets, and might even add additional support to risk assets in Japan in the near term. Monetary easing programs are generally good for risk assets – abundant liquidity generally keeps interest rates low which can help steer investor assets into higher yielding securities, like stocks. Additionally, to the extent that monetary easing programs help lift the economies of Japan, Europe, and China, it can provide a boost to global GDP growth which could provide stocks additional tailwinds.
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