In a surprise move the Bank of Japan (BoJ) has taken rates into negative territory with a 20 basis point cut to -0.1% for the rate it charges to financial institutions on their current accounts with the central bank.
Asset purchases will continue at the same rate and the new policy will be known as "Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate".
In effect the BoJ is continuing with QE, but also adopting a system like that used in Switzerland where banks face a tiered interest rate which gets progressively worse as their deposits at the central bank rise. The negative interest rate will only apply once deposits exceed a certain level and the aim is clearly to push down rates at the short end of the yield curve and ultimately encourage banks to lend their excess deposits into the real economy.
Bonds and equities have rallied worldwide in response to another central bank easing monetary policy and it follows dovish comments from both Mario Draghi at the European Central Bank and Bank of England Governor Mark Carney.
However, today’s move also follows a difficult period for Japan which has seen some weak activity indicators and the yen rise significantly over the past month, thus diminishing the prospects for hitting its 2% inflation target. In particular, the yen has borne the brunt of China’s new exchange rate policy and at one stage this month was up 4% in trade-weighted terms. It has now fallen back, but alongside today’s action the BoJ has pushed out its target for inflation to return to 2% by six months to the middle of 2017.
So, despite the market reaction, this move comes out of weakness and also raises the risk that China may retaliate with a further depreciation of its currency. If so, we will have entered a new phase in the currency wars where countries fight over a limited amount of global growth, an outcome which does not bode well for risk assets.
