The Bank of Japan's Negative Rate Gamble

The Bank of Japan’s (BOJ) newest policy tool is likely to be the lynch pin in future Japanese economic stimulus, the question remains if it should be. After unveiling negative interest rates (NIR’s) in January as a means to incentivise consumption and investment, a move which is hoped to fight back against deflationary pressures, the Yen rallied against the greenback. At face value this may appear to signal the market’s optimism towards any economic stimulus the policy could provide. However, due to its relatively recent introduction into monetary policy, it still begs the question, do NIRP’s work and are market expectations in line with reality?

Effectively NIR’s impose a tax on the savings of residents and companies, making consumption and investment a more attractive prospect. What they do not do however, is specify where this consumption is shifted to. If it accrues to domestic producers it then encourages growth as does increased investment in productive industries, especially those that export. This is generally the intent of NIR’s. The increase in exports justifies an appreciation of the Yen, driving inflation in Japan as the world demands more of its currency to buy its goods. It is also true that there could be some incentive to invest abroad and increase Japan’s Net Foreign Factor Income (NFFI). The negative interest rate having the effect of making investing in Japan less attractive, this all while Japanese savings are being freed up for use in investment. However, NFFI usually accounts for very little national income and therefore its overall impact on the Japanese economic position is debatable.

However, the movement of the Yen seems to be doing the opposite of what it should be. A fall in the value of the Yen could have made Japanese exports more attractive once more, fuelling inflation and achieving the actual intended ends of the policy. The short term rallying of the Yen serves to only enable and incentivise Japanese companies and residents to spend their savings overseas, remembering of course that the negative interest rate has also incentivised savings to be withdrawn and spent. This present rally could ultimately be offset by the reduction of the Japanese trade balance resulting from increased imports into Japan, potentially leaving the Yen more or less in a similar position to where it was prior to the policy coming into effect with no net increase in domestic consumption.

It is important to understand that any positive, short term effect of NIR’s may have been exaggerated by the Q4 repatriation of Japanese capital as their financial year begins to come to a close. Furthermore, technical indicators still signal that the latest rally is quite probably a continuation of the downward trend that the USD/JPY pair formed Mid-December last year. The channel that formed has barely had its upper and lower constraints tested, even with the increased selling pressure. The pair is also yet to breakout from its current support and appears to be consolidating and while it may have experienced a bearish movement, it seems to be sort lived. The real effect of the NIR’s will be seen in the inflation and consumption data coming out of Japan in the next few months.