The Bank of Japan lived up to its reputation of surprising markets by adopting negative interest rates today in a bid to lift price levels in Japan. At its first policy meeting of the year, the Bank decided to introduce a negative interest rate of -0.1% on current accounts that financial institutions hold at the Bank, which effectively results in a 20bps reduction from the present rate of 0.1%.
Only last week, the Bank’s governor, Haruhiko Kuroda had strongly opposed such a move in remarks made at Davos, saying there were no plans to adopt negative rates for now. The Bank had also surprised markets in December by announcing some unexpected tweaks to its asset purchase program.
The Bank of Japan is only the second major bank to adopt negative rates after the European Central Bank. However, the decision vote was very close with only a 5-4 majority, signalling some divisions within the policy board. There were no changes to the Quantitative and Qualitative Monetary Easing program, which was maintained at 80 trillion yen per year. Another concern is that the three-tier system that the BoJ has decided to introduce may prove less effective than the ECB’s system as negative rates will only apply to new bank reserves resulting from its asset purchase program.
Speaking at the press conference after today’s announcement, Kuroda said the Bank is committed to do whatever it takes to meet the price target. He explained that the decision of negative rates was in response to the downside risks to Japan’s economy and on inflation. Although underlying price trends have been improving, deflationary mindsets run the risk of weakening long-term inflation expectations even further, according to Kuroda.
In its latest outlook, the Bank once again pushed back the date it expects to hit its 2% inflation target by six months to between March and October 2017. It also lowered its CPI forecast for 2016/17 to 0.8% from 1.4%. For 2015/16, its forecast was unchanged at 0.1%. GDP growth forecast was revised down to 1.1% from 1.2% in 2015/16, but increased to 1.5% from 1.4% for 2016/17.
Given the current headwinds facing the global economy, particularly, falling commodity prices and slowing growth in emerging economies such as China, there’s a good chance today’s revised projections will get lowered again in the coming months. The Bank firmly left the door open for further cuts, noting in its statement that it will reduce the rate further into negative territory if necessary.
The yen, which had a strong start to the year as the volatility in financial markets has given rise to risk aversion, fell sharply against other currencies after the decision. The dollar jumped to 121.41 yen from around 118.50 yen before the announcement. It fell back as the shock receded but it’s since started to climb again towards the 121 level, trading just below it in mid-European session. The euro and the pound both also rose strongly against the yen, climbing to 132 and 173 yen respectively.
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