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Negative rate not having intended effect

TOKYO -- A negative interest rate policy on Tuesday introduced itself to the Japanese money market. Stock market players, however, breathed a sigh of relief as the Nikkei Stock Average continued its recent rise.

     Still, concerns remain over the China-led global economic slowdown and Europe's financial system.

     A representative of an online brokerage questioned whether the Nikkei average hit bottom on Friday, when it closed at 14,952. "It is still unknown," the representative said.

     Market attention is shifting to a meeting of finance ministers and central bank chiefs from leading rich and developing nations. The Group of 20 meeting is to be held in Shanghai on Feb. 26-27.

     Markets are likely to keep fluctuating. And there are concerns that the Bank of Japan's negative interest rate policy could play out poorly. Consider Japan's annual spring wage negotiations. "More companies may become more cautious about raising wages," said Hisashi Yamada, chief economist and general manager of the economics department at the Japan Research Institute.

     The central bank on Jan. 29 adopted "the most powerful monetary policy framework in the history of modern central banking," as Gov. Haruhiko Kuroda put it. Kuroda's hope is that the move weakens the yen, thereby giving Japanese exporters a lift, and moves stock prices higher, giving companies reasons to raise wages and boost capital spending.

     At a party in early January hosted by the Japanese Trade Union Confederation, known as Rengo, Kuroda said a strong wind (for wage hikes) is blowing in favor of workers.

     Kuroda believes big pay increases are necessary to achieve the BOJ's 2% inflation goal. However, the yen has appreciated and stock prices have declined since Kuroda announced the negative interest rate policy. This bodes ill for wages.

Contrary to intentions

The BOJ's negative interest rate policy so far has been unsuccessful for three reasons, including a lack of luck.

     Since the announcement, investors have become more risk-averse. There are worries over Deutsche Bank's creditworthiness and fears of a possible bankruptcy of Chesapeake Energy of the U.S. When investors sense risk, they tend to gravitate toward what they perceive as safe bets. The yen is one of these bets.

     This helps to explain why the yen was trading in the 110-range to the dollar in London on Feb. 11. The Nikkei average dropped to the 14,000 mark the following day, perhaps tumbling too much, based on past trends.

     The way Abenomics -- Prime Minister Shinzo Abe's economic policies -- has played out, the Nikkei average should be between 15,500 and 17,000 to balance out a yen that trades at 110 to 115 to the dollar.

     Secondly, there are expectations that U.S. interest rates will decline. This would narrow the gap with Japanese interest rates -- even if real-world Japanese rates follow the BOJ into negative territory.

     The BOJ's policy applies to a portion of the reserves that Japanese lenders keep with the central bank. Essentially, the lenders will be charged 0.1% on that portion of their reserves.

     In testimony before Congress, U.S. Fed Chair Janet Yellen last week hinted that no rate hike would be coming in March, when the Federal Open Market Committee next meets. In December, the Fed raised its policy rate, which was near zero, for the first time in nearly 10 years. Now that it appears the Fed will not move forward with further rate hikes, the gap between U.S. and Japanese real-world rates could narrow and the yen could gain ground on the dollar.

     Thirdly, the fact that the BOJ is pulling the negative lever shows that it has few good policy options left. Even this slight move into negative territory could backfire. Indeed, bank stocks tumbled after the policy was announced. Investors were concerned that the new interest rate environment would lead to the evaporation of lenders' earnings.

     The new policy should lead to a decline in lending rates. Deposit rates, on the other hand, are unlikely to fall since they are already near zero. Thus, the negative interest rate policy could eat into banks' profits. It could also lead to less lending, contrary to central bank's intention.

More enticing

The BOJ's latest policy could push down operating profits at major Japanese banks by 8%, while regional banks could see their operating profits dropping 15% in the current year, Standard & Poor's Ratings Services of the U.S. said on Monday.

     Junichi Makino, chief economist at SMBC Nikko Securities, has a different take. Because Japanese banks can earn capital gains by selling government bonds at a negative interest rate, the BOJ's new policy is likely to help boost bank earnings by a total of 50 billion yen ($432 million).

     So far, the policy has not delivered the desired effect. The Nikkei average fluctuated wildly this month, dropping from the 17,000 range on Feb. 8 to the 16,000 mark on Feb. 9, the 15,000 level on Feb. 10, and to the 14,000 range on Friday. The index rebounded to the 16,000 mark earlier this week but fell below the level on Wednesday.

     On Friday, the index's plunge put it 21.4% below where it was at the start of the year -- at the time the fourth-largest year-to-date decline among 91 markets around the world, behind only China's -21.9%, Italy's -22.9% and Greece's -28%.

     With government bond yields going negative, global market players are looking to park their money in so-called "new sovereign stocks" -- shares of companies with sound financial health, high yields and liquidity. Camera maker Canon, with a dividend yield of 4.83% and equity ratio of 67%, as well as menswear chain operator Aoyama Trading, with a dividend yield of 3.83% and equity ratio of 67.2%, are considered new sovereign stocks.

     It is unknown how much money has shifted from government bonds and BOJ reserves to new sovereign stocks, but the negative interest rate policy seems to have made them look more enticing.


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