Last week the Bank of Japan decided to go negative with interest rates. The BOJ cut rate on new reserve deposits held at the bank to -0.10% from +0.10% and hinted that it could reduce rates further into negative territory. Why did the BOJ decide that it needed to punish banks with negative rates to stimulate its economy?
Apparently after years of running the printing presses at full tilt to buy up everything from government bonds to Japanese stocks (the BOJ owns half of the ETF market in Japan), in what has turned out to be a futile attempt to hit a 2% inflation target, the BOJ has decided to try a different tactic.
If monetizing over 30% of Japan’s outstanding government debt and maintaining a balance sheet that is now equal to over 70% of Japan’s annual GDP didn’t ignite the inflation desired, what is siphoning a few basis points from private sector wealth going to do?
The BOJ joins the European Central Bank and the central banks of Denmark, Sweden, and Switzerland that have also cut rates into negative territory. The latter three have gone negative only because they have little choice. The poor souls who live in countries that use the ill-fated euro would much rather hold francs, krona, or krone than euros, but Denmark, Sweden, and Switzerland are tiny compared to the euro-area. Hot money flows into these countries can unduly drive up the value of their currencies and destabilize their economies. Negative rates are a deterrent to safe-haven flows.
The BOJ stimulus surprise appeared to give global equity markets the spark to finally clear the oversold conditions that have persisted all year. Whether the rally was simply a function of the BOJ scaring the shorts out of their positions or the start of a more genuine recovery is not yet clear.
It is surprising that markets would take the BOJ’s renewed efforts to debase the yen (that’s what negative rates tend to do) as bullish for anything but Japanese stocks. Debasing the yen accentuates the deflationary impulse in the global economy and is ultimately more negative than positive for global growth.
The BOJ is a big export-oriented economy. When it debases its currency it weakens growth, causes competitor nations to retaliate with currency weakening monetary policy and that ultimately leads not to higher inflation, but to lower inflation.
The embrace of negative interest rates by the global central banking cabal should be taken as a sign that monetary policy has gone off the rails for good. Central banks have few if any sensible policy tools left in their arsenal. Anything beyond a few basis points into negative territory for rates is probably unsustainable in the medium-term. If central banks try to go too far down this rabbit hole, investors, bankers, and depositors will start to hoard cash—it’s shocking they aren’t doing this already.
Jeremy Jones, CFA
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