Bank of Japan Introduces Negative Interest Rate to its Deflation-Fighting Toolbox

January 29, 2016

The five hour seventeen minute Policy Board meeting over two days surprised and electrified world financial markets with a statement that by a 5-4 vote added a negative interest-rate dimension to its nearly three-year-long experiment with quantitative and qualitative monetary easing.  Reserves held by the BOJ for financial institutions will from mid-February be earmarked for one of three tiers.  The largest, consisting of outstanding current account balances that already exist, will still earn 0.1% interest, but the bulk of newly created reserves related to BOJ asset purchases will be subject to a negative 0.1% penalty charge that could be lifted further in the future.  This is analogous to the negative interest rate now employed by several European central banks.  The middle tier will carry a zero interest rate and has been established to neutralize disincentives that would otherwise discourage use of the BOJ’s facilities that are meant to promote bank lending for specific purposes.  BOJ officials believe the new complicated three-tier system will not damage the profitability of banks.

The BOJ meeting coincided with publication of a new quarterly Outlook for Economic Growth and Prices with revised macroeconomic forecasts.  The report makes clear that a change in the policy stance was prompted by a lower assumption of crude oil prices that will delay six months the projected timing of the CPI reaching around 2% to sometime in the first half of fiscal 2017.  In conjunction with continuing asset purchases of 80 trillion yen annually and a lengthening of the central bank’s asset portfolio average maturity, the negative interest rate is meant to counter “an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected” as a result.  Officials expect not just the shortest end of Japan’s yield curve but its entirety to move lower as a result of today’s policy changes.  The new macro forecasts project GDP increases of 1.5% in fiscal 2016, which begins in April, followed by just 0.3% in fiscal 2017 when consumption taxation will again be raised.  While these projections are very similar to ones made last October, the forecast for core CPI inflation has been slashed to 0.8% from 1.4%, because 0.6 percentage points is the estimated direct impact on the CPI of the lower oil price assumption.  Officials, however, are still projected core CPI inflation in fiscal 2017 of 1.8%, excluding the effect of the consumption tax hike.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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