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Doubts hang over how low short rates will go

TOKYO -- With a week to go until commercial banks feel the sting of the Bank of Japan's negative interest rate, money market watchers are trying to gauge the extent to which an influx of hitherto idle funds will depress short-term interest rates.

     The BOJ intends the minus 0.1% rate, to be slapped on a portion of current-account deposits held at the central bank starting next Tuesday, to do just that: nudge interbank call rates downward. Banks loath to pay a charge for parking money at the BOJ can try for a better deal in the short-term market. Logic holds that they should, as long as rates there are even slightly less negative.

     But some question whether things will go according to plan, considering the practical difficulties that stand in the way. Banks' money market trading systems "can't handle negative interest rates," an insider says. While negative-rate transactions could be worked by hand, this added inconvenience may limit activity.

     With a limited pool of institutions lending at negative rates, "the unsecured overnight call rate may remain in positive territory for a while," said Kiyoshi Iida at Totan Research.

     This cannot be dismissed as a minor problem. BOJ Gov. Haruhiko Kuroda described pushing down the bottom end of the yield curve as the crux of the negative interest rate policy.

     The bond market is already anticipating less-than-zero short-term rates. Yields on government debt with up to nine years remaining until maturity have all dipped into negative territory.

     "The bond market is looking overheated," says a trader at a domestic brokerage. If short rates fail to comply, a correction would be sure to follow.

      Yusuke Ikawa, desk strategist at UBS, says that the policy "may come to be regarded as ineffective on interest rates, potentially triggering a rebound in long rates."

      Kuroda stressed that the BOJ can take monetary easing further in three dimensions -- quantity, quality and interest rates. Yet a failure to move short rates in the intended direction would raise questions about its methods.

     The BOJ's potential for scaling up its asset-buying program is already in doubt. The negative interest rate policy was partly meant to dispel the suspicion that the bank is running out of room to maneuver. Should this effort meet with the same doubts, the consequences would be significant. Kuroda may have no other choice but try to force the market into submission with a more punitive rate.

     Nervous days lie ahead ahead for the money market and the BOJ.

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