Negative Rates: Explaining the BoJ’s reticence

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David Keohane
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You’ll have noticed that the yen and Nikkei were displeased yesterday. Like throw your toys out of the pram because you didn’t get what you wanted displeased. Like one of the worst one day JPY moves in the past decade displeased.

What they didn’t get, and what prompted that tantrum, was any auld bit of easing from the Bank of Japan.

And here are eight potential reasons why the BoJ disappointed, from SocGen:

1) there is a risk that the market may once again perceive limits to the effectiveness of monetary policy if additional QQE were to be implemented;

2) the BoJ pushed back the timing to achieve the 2% inflation target but did not implement additional QQE… [The BoJ also said that Japan’s economy has ‘continued its modest recovery trend’ so…] If the BoJ is to implement additional QQE by end-2016, it will probably need to admit that the Japanese economy is not “recovering”. Considering that the global economic uncertainty has been reduced, the possibility is low;

3) the BoJ has various policy measures and increasing the balance for the negative interest rate also has an easing effect [and, say SG, it can do that without a mon pol board decision];

4) there is also a risk that a decision to implement additional easing could influence PM Abe’s political judgement on the next consumption tax (CT) hike and the dissolution of the lower house;

5) arbitrage transactions among financial institutions need to be more active for the BoJ to expand its QQE with the negative interest rate;

6) if the BoJ implements additional QQE, yen depreciation and a stock market rally could be limited or temporary – this could lead to a larger risk of the BoJ losing confidence;

7) what are really necessary are fiscal stimulus and policy measures to stimulate corporate activities and expand net domestic fund demand; and

there is a risk that additional QQE by the BoJ will be perceived as using monetary policy as a currency devaluation tool.

We’ve talked about most of this stuff before, particularly the idea that markets saw the BoJ’s adoption of NIRP as a sign they were running out of monetary steam, and the idea that there is increased international pressure to not intervene in the currency. Where the latter is concerned there is perhaps a case that any additional QQE from the BoJ should be saved for when it’s really needed. And where the former is concerned one has to keep in mind that Japan hosts the G7 Summit in May.

But what we might add to here is the idea started on in point 5 above — again, already discussed — that NIRP has hurt Japan’s banks. (You can see what European banks think of their version of the policy on page 27 of April’s ECB bank lending survey, but do also note that evidence is mixed.)

Here’s the expanded section from SocGen:

The BoJ’s negative interest rate policy is not highly regarded by either financial institutions or by the Japanese people at large. It seems like financial institutions are still struggling to adapt to the new system under the negative interest rate policy. In fact, financial institutions have not fully used the upper bound balance to which positive interest rates and zero interest rates are applied as compared to the BoJ’s estimate. Those which have not reached its upper bound on these balances can use more arbitrage transactions among financial institutions in the overnight call market. If arbitrage transactions take place in full, the balance to which the negative interest rate is applied should turn out to be less. The negative interest rate policy could be felt to be a burden on financial institutions and Japanese retail investors. This may then become a risk to the economy, especially as it could also prevent moves towards reconstruction after the earthquake disaster in Kumamoto. The government is probably not willing to take any form of action that could further disappoint the Japanese people ahead of the upper house election this summer.

In order to reduce the burden on financial institutions from the negative interest rate policy, arbitrage transactions among financial institutions need to be more active. If the BoJ is to implement additional QQE, the Bank needs to make sure such transactions become more active.

To put even more stress there, it seems fair to say that the BoJ might have a considerable political hurdle to climb before it can push into further negative territory. Particularly where the banks are concerned. Kuroda though seems confident that their criticisms will fade, as Goldman’s Naohiko Baba said:

The post-MPM press conference also featured an interesting discourse between Governor Kuroda and assembled journalists on the BOJ’s negative rate policy. Questioned about his views on financial institutions’ criticism of the policy, Mr. Kuroda essentially argued that resistance would diminish going forward. More specifically, he said that monetary policy was not conducted for the sake of financial institutions and that their approval/opposition was not a consideration in policy decisions. He went on to say that the adverse effects of negative rates on financial institutions would be minimal, and that their criticism reflected the difficulties they were facing having to deal with such a policy for the first time. His responses give us the impression that the BOJ would be ready to go deeper into negative rate territory as a key plank of monetary policy once banks’ criticism eases to some extent.

But we wonder if that easing of criticism will cost him? As BNP Paribas’ Ryutaro Kono suggests:

The focus of the government has already started shifting toward fiscal stimulus, as those around the prime minister increasingly feel that they can no long depend on monetary policy. In fact, moves are afoot within the ruling LDP to start a campaign against the BoJ’s negative interest- rate policy because LDP lawmakers have recently started receiving petitions from their constituents in regional areas who want the government to stop the “out-of-control” BoJ, whose policies are hurting local lenders and their customers. Such opposition within the ruling party could tie the BoJ’s hands.

That said, the BoJ has no realistic option other than deepening the negative rate if dramatic yen appreciation threatens to pull the plug on share prices (of course, there is no guarantee that a further rate cuts can do the job)….

In order to deepen the negative rate, the BoJ will have to repair its strained relations with banks.

One way to do this is to start providing the banks with financing at the negative interest rate, and apply a zero rate to reserve balances corresponding to that lending. We expect the BoJ will eventually do this under not only the fund provision scheme for disaster areas but also its Loan Support Program (the funding for lending scheme).

Food for thought ahead of the next BoJ meeting.

As Goldman say, “it is only a matter of time before the BOJ will need to take further easing action. However, it is now more difficult to make any logical estimate of when that timing might be. While a key gauge will be the timing of any easing in banks’ resistance to negative rates, when that will actually happen is highly uncertain.”

SocGen, fwiw, “calculate the probability of the Bank of Japan (BoJ) implementing additional “quantitative and qualitative monetary easing (QQE) policy with a negative interest rate” by end-2016 to be 25%.”

That’s down from 30 per cent.

Related links:

Jefferies: Japan has a fever and the only prescription is NGDP targeting and zero coupon perpetual bonds – FT Alphaville
Did the G20 agree a currency accord and does it matter? FT Alphaville
In 10 years time, what will we think about negative yields? Weldon, Medium
The widowmaker doesn’t care if this is nuts – FT Alphaville
The BoJ has started helicopter drops – The Philosophy of Money