Bank of Japan Gov. Haruhiko Kuroda has surprised the market again by introducing a negative interest rate, but the decision indicates the central bank has been pushed into a corner in its battle against deflation.
The new easing measure, which one analyst likened to a “powerful drug,” could have both positive and negative effects. It gives the central bank more room to ease but also runs the risk of turning into a poison and harming financial institutions.
“By adding an option for easing from the perspective of interest rates, we will make full use of easing measures with three dimensions — quantity, quality and interest rates,” Kuroda told a news conference Friday after a two-day policy meeting.
The BOJ chief said it is also capable of further cutting the interest rate on current accounts held at the bank by financial institutions, in addition to increasing its purchases of government bonds if necessary to address the downside risks to the economy and consumer prices.
Equity markets appeared to welcome the BOJ’s decision, with the key Nikkei stock index closing sharply higher.
The dollar briefly surged to the ¥121 level, its highest in 1½ months, while the yield on the benchmark 10-year Japanese government bond fell to a record low of 0.090 percent at one point.
Sadayuki Sakakibara, chairman of the influential business lobby Keidanren, also known as the Japan Business Federation, expressed the view that the measure would be effective as the BOJ tries to improve sentiment following turmoil in financial markets and tumbling crude oil prices.
“Governor Haruhiko Kuroda has said that the bank will carry out any measure without hesitation, and the negative interest rate was part of it,” he told reporters.
Masaaki Kanno, chief economist at JPMorgan Securities Japan Co., said the BOJ was “forced to use a powerful drug” to impress the market, but added that the step would diminish the interest rate market by making financial institutions reluctant to buy government bonds.
“The measure had certain effects” by preventing a firming of the yen and stocks from losing further ground, Kanno said. “But the markets will ask for more,” he added.
“The BOJ is likely to continue facing a long and painful road ahead” as the headwind is becoming stronger, Kanno said.
The decision came on the heels of sluggish economic data that could undermine corporate and consumer sentiment amid a slowdown in China and other emerging economies and plunging crude oil prices that have disrupted global financial markets.
Reflecting weakening exports, industrial output fell a seasonally adjusted 1.4 percent in December from the previous month, worse than the around 0.3 percent decline predicted by the market.
Personal consumption has also yet to recover, with household spending dropping 4.4 percent in December from a year earlier due partly to sluggish sales of winter clothing amid warm weather, while wage growth remains slow.
Pressured by sharp declines in energy prices, core consumer prices excluding fresh foods rose only 0.1 percent in the month from a year earlier, again far below the BOJ’s 2 percent inflation target.
“There are growing risks that the improvement in corporate confidence and conversion of the deflationary mindset will be affected by current global economic conditions,” Kuroda warned. “The measure is aimed at preventing such risks from materializing,” he added.
While the new measure could prompt banks to increase lending by further shaving interest rates and boosting investment, there will be a risk to their profits as they will now have to pay to keep some of their savings at the central bank.
To ease concern that a negative interest rate would erode banks’ profits, the BOJ will only apply a minus rate to a part of the outstanding balance of financial institution’s current accounts.
But such side effects may not be small, as the negative interest would affect market interest rates and is likely to reduce profits at commercial banks, said Kentaro Koyama, economist at Deutsche Securities.
Some economists say the new step could also make it difficult for the BOJ to continue massive buying of government bonds from financial institutions, as it would be less attractive for them to manage their funds with a negative interest rate.
“The negative interest rate policy is likely to have more negative effects than positive ones,” said Koyama.
BOJ Gov. Kuroda showed confidence that the additional easing measure would stir personal consumption and investment to help the economy expand and lift consumer prices toward 2 percent inflation.
But many economists maintain the view that the BOJ will continue to face difficulties pursuing the target despite again delaying the timing of achieving the goal to around the first half of fiscal 2017.
“With lending interest rates at Japan’s financial institutions already low at around 1 percent, there is little room for further reduction,” Koyama said. “The impact of the step on interest rates in the real economy will be limited.”