BoJ Surprises With Negative Interest Rate, Delays Inflation Target Timing Again

By Shuli Ren

How to read today’s statements from the Bank of Japan?

The BoJ kept its current plan of 80 trillion yen annual rise in monetary based unchanged and delayed timing for reaching its 2% inflation target for the second time to fiscal year 2017.

However, the BoJ did throw financial markets some bones by saying it will introduce negative interest rate for the first time, allowing -0.1% to be applied to current accounts held by Financial Funds. “It will cut the interest rate further into negative territory if judged as necessary,” the Bank wrote in a statement.

Allowing a negative interest rate will help the BoJ “achieve the price stability target of 2 percent at the earliest time,” said the BoJ.

This additional easing measure came as the BoJ fretted over the “further decline in crude oil prices” and “uncertainty … over the Chinese economy.” “For these reasons, there is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed.”

The imposition of a negative interest rate was a surprise. PNC economist Bill Adams wrote:

PNC Economics had expected for the BoJ to signal today that easing was likely at some point in 2016, but to leave its monetary stance unchanged. The surprise easing is a reaction to the reduced outlook for inflation in 2016-2017 as a result of January’s plunge in global oil prices. The BoJ now forecasts that Japanese CPI inflation excluding fresh food (in year-ago terms) will average 0.2 to 1.2 percent between April 2016 and March 2017, down from their forecast of 0.8 to 1.5 percent in their prior forecast round in October 2015.

This morning, Japan reported disappointing December industrial output growth, while its capital Tokyo fell into deflation in January.

Nomura Securities sees today’s negative interest rate as an opening to future easing:

The Bank did not introduce a lower bound for JGB yields on its JGB purchase operations. Thus, the BOJ can purchase JGBs at -10bp or even lower, even if yield continues to decline… The Bank clearly stated that it can cut further when necessary, which suggests -10bp is not a lower bound. The BOJ referred to rates in Switzerland (-75bp), Sweden (-110bp) and Denmark (-65bp), all of which suggest the BOJ views much lower rates as possible.

To consider actions in the medium term, the composition of BOJ board will be worth monitoring. There are four dissenters (Mr. Kiuchi, Mr. Sato, Mr. Ishida and Ms. Shirai), but Ms. Shirai (March) and Mr. Ishida (June) will retire this year. More dovish board members will likely be appointed by PM Abe, which will enable the BOJ to consider more aggressive cuts if necessary, in our view.

Will we see a currency war? At the margin, the BoJ’s decision could prompt Asian central banks to cut rates. “We are already forecasting 50bp of rates cuts this year in Korea, Taiwan and Thailand, and the risk is the timing could be brought forward. We also see a rising risk of [Singapore's] MAS easing its NEER policy in April, or possibly before like last year,” noted Nomura Securities today.

Asia markets were volatile after BoJ’s surprise decision. The yen weakened sharply, falling by 1.37% to as low as 120.42 per dollar. The Nikkei 225 oscillated between red and black and closed 2.8% higher. This is because Japanese banks tanked after the rate announcement. Mitsubishi Financial fell 4.9%, Sumitomo Mitsui was down 4.5%.

Currency war? The worry there was fleeting too. I can see that: If the BoJ did not push back its inflation target timing, the negative interest rate would be widely read as a currency war signal.

The offshore yuan fell sharply to as low as 6.6528 before settling down back little changed to 6.6148. Similarly, the Singapore dollar dropped to as low as 1.4308 before settling down 0.27% firmer at 1.4227.

The volatility in yen is affecting gold prices too. Gold dipped to as low as 1108.80 before settling back up to 1113.70.

Overnight, the iShares MSCI Japan ETF (EWJ) rose 0.2%, the iShares Hedged Currency MSCI Japan ETF (HEWJ) gained 0.4%, the SPDR Gold Trust ETF (GLD) fell 1.1%, the Powershares DB US Dollar Index Bullish Fund (UUP) fell 0.5%.