Japan: BOJ into uncharted territory
2 February 2016
Economics
Japan: BOJ into uncharted territory
DBS Group Research
2 February 2016
• For the first time, the BOJ starts to charge interest on banks’ excess reserves
• Credit transmission remains uncertain
• The inflation and growth outlooks remain elusive
• The financial market impact may be greater than the real economy one
• JGB yields will continue to face downward pressures
• The BOJ’s rate move per se is only a moderate surprise compared to the
previous two actions on QQE in 2013 and 2014
The Bank of Japan (BOJ) will implement negative rates on financial institutions’
excess reserves in a move to address the downward pressure on inflation / inflation expectations. Effective from 16th Feb, the BOJ will charge 0.1% on the
amount of new deposits that exceeds required reserves. Further rate adjustments
are possible according to the BOJ, depending on economic developments.
This is the first time the BOJ applied negative rates to banks’ reserves. Similar experiences have only been witnessed in Europe in recent years. In order to combat
deflation, the European Central Bank (ECB) has pushed the interest rates applied
on its deposit facility below zero since 2014, and Sweden’s central bank followed
suit in 2015. The central banks in Switzerland and Denmark also instituted similar
policies in recent years, albeit for different reasons – mainly to contain capital
inflows and relieve upward pressure on their currencies.
The credit transmission channel may or may not work
By charging interest rates on banks’ excess reserves, the BOJ hopes to encourage
bank lending into the economy so as to support consumption and investment.
Success is not guaranteed. Banks won’t necessarily pass on the negative rates to
customers for fear of losing them. They may choose to tolerate a small loss in
earnings rather than to lend to perceived risky borrowers.
Alternatively, if banks decide to pass the negative rates to customers, it may help
to revive credit growth, but also hurt the depositors. For an aging economy like
Japan, the adverse impact of negative deposit rates on pensioners and other
fixed-income earners can't be dismissed. The overall impact of negative rates on
consumption and domestic demand is likely to be mixed.
Deposit and lending rates in Japan’s banking system have fallen to record lows
since the BOJ introduced the quantitative and qualitative easing (QQE) program
in 2013. But loan growth has picked up only slightly from 1.8% in 2013 to 2.5% in
2015 (Chart 1). Loan demand has been sluggish due to structural factors, namely,
the aging of population, shrinking of domestic consumer base, and relocation of
corporate investment to overseas emerging economies. It is hard to imagine a
Ma Tieying • (65) 6878-2408 • matieying@dbs.com
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Japan: BOJ into uncharted territory
2 February 2016
Chart 2: Eurozone: credit growth vs. interest rates
Chart 1: Japan: credit growth vs. interest rates
% pa, % YoY
% YoY
4
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
Jan-08
3
2
1
0
-1
Bank loan growth
-2
Avg lending rates: new
loans
Avg time deposit rates
-3
Jan-08
Jan-10
Jan-12
Jan-14
% pa
Corporate loan growth
3.5
Household loan growth
3.0
ECB: rate on deposit
facility (RHS)
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
Jan-10
Jan-12
Jan-14
modest further decline in capital costs tackling these structural problems. In the
Eurozone, even after the ECB introduced a negative deposit rate in 2014 and cut
it twice from -0.1% to -0.3%, credit growth has risen only marginally in the past
1.5 years (Chart 2).
The inflation outlook remains elusive
The BOJ also hopes that negative rates will boost public inflation expectations so
as to encourage consumers to spend and businesses to invest. But inflation expectations are influenced by many factors including exchange rates, the output gap
and commodity prices, amongst others. The two charts below show that inflation
and inflation expectations in Japan were most correlated with the movements
in JPY and oil prices in recent years, if stripping out the distortion impact from a
consumption tax hike.
Negative rates could weaken the JPY, lift import prices, and therefore boost inflation/inflation expectations. But oil prices will remain a wild card and they are not
under the control of the BOJ. If global oil prices were to remain low on the back of
supply-demand imbalance, it would continue to pose a threat to Japan’s inflation
outlook and put pressure on the BOJ to ease policy further later this year.
Chart 3: Japan: inflation vs. JPY, oil prices
Chart 4: Japan: inflation expectations vs. JPY, oil
% YoY
3.0
2.0
CPI (tax adjusted)
USD/JPY (RHS)
Oil import prices in US$ (RHS)
1.0
160
140
140
120
120
100
100
0.0
80
60
-1.0
40
-2.0
-3.0
Jan-08
20
0
Jan-10
Jan-12
Jan-14
80
60
% consumers expecting
prices to go up
USD/JPY
40
20
0
Jan-08
Oil import prices in US$
Jan-10
Jan-12
Jan-14
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Japan: BOJ into uncharted territory
2 February 2016
Chart 5: Japan: JGB yields
Chart 6: Germany: Bund yields
% pa
% pa
2.00
1Y
3Y
5Y
10Y
5.00
1Y
3Y
5Y
10Y
4.00
1.50
3.00
1.00
2.00
0.50
1.00
0.00
-0.50
Jan-08
0.00
Jan-10
Jan-12
Jan-14
Jan-16
-1.00
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Impact mainly in the financial markets
The impact of the BOJ’s latest policy move is likely to be reflected in the financial
markets more than in the real economy.
Bonds: Negative returns on reserves should prompt banks to look for other liquid,
risk-free assets to substitute, which benefits sovereign bonds. The 1-3Y JGB yields
have already turned slightly negative since late last year, due to the large-scale
bond purchases by the BOJ under the QQE program. The 5Y yield also dipped
below zero last Friday, immediately after the BOJ announced the negative rates
policy (Chart 5). In the Euro Area, short-term government bonds in the highlyrated countries (e.g., Germany, Austria, the Netherlands) also recorded negative
yields after the ECB cut deposit rate in Jun14 (Chart 6).
The phenomenon of negative bond yields could persist. Banks would continue to
hoard government bonds if they expect capital gains returns to offset the negative yields, such as due to the BOJ’s expansion of bond purchases, or an increase
in bond demand caused by heightened risk aversion. This means bond prices will
remain distorted for some time – failing to reflect the risks of Japan’s rising public
debt and downgraded sovereign credit ratings.
Equities: Negative rates on reserves could encourage financial institutions to buy
equities and other risk assets. The Nikkei reacted positively to the BOJ’s policy announcement last Friday. But a high degree of uncertainty remains. Slow global
growth, low oil prices and a strong US dollar weighing on emerging market debt
all factor into the risk equation.
Yen: Negative rates should weaken the currency. In search of positive yields, Japanese financial institutions could allocate more funds into foreign bonds/equities,
and increase the cross-border lending to foreign counterparts. The incentives for
carry trade between the JPY and the high-yield currencies would also be strengthened. Unsurprisingly, the yen has depreciated notably against the dollar since last
Friday, moving from the 118 level to 120-121. Currency depreciation was also witnessed in the Euro Area after the ECB adopted negative rates in Jun14.
Still, capital flows and carry trade depend on the development in global risk environment and the factors noted above are relevant here as well. From this perspective, the BOJ’s policy move Friday only came as a moderate surprise, both in
terms of the timing and the form of easing. The psychological impact may be shallower than that of the previous two moves in 2013 (when the BOJ made a policy
overhaul to establish the QQE) and in 2014 (when the size of QQE was expanded
as the Fed‘s QE wound down). Markets could continue to demand bolder easing
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Japan: BOJ into uncharted territory
2 February 2016
measures from the BOJ going forward – a further expansion in the scale of asset
purchases. But given the re-activation of the interest rate tool, whether QQE expansion remains the BOJ’s priority option has become increasingly unclear.
Sources:
All data are sourced from CEIC, Bloomberg. Forecasts and transformations are DBS
Group Research.
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Japan: BOJ into uncharted territory
2 February 2016
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