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BOJ's negative rate policy still only halfway to intended results

Bank of Japan Gov. Haruhiko Kuroda

TOKYO -- Tuesday marked six months since the Bank of Japan introduced negative interest rates, and the effects and drawbacks of the unusual step have come to the fore.

The policy has yet to produce falls in the yen's value, arousing concern about adverse effects on earnings at financial institutions, while steep drops in market interest rates have stimulated housing-related loans and investment. It thus remains halfway to its target of stimulating the real economy to push up prices.

Negative interest rates "will help the [Japanese] economy expand by stimulating investment and consumption," BOJ Gov. Haruhiko Kuroda said as he announced the central bank's decision in late January to adopt the new strategy. "Together with an increase in inflation expectations, the rate of price growth will move toward 2%," he said.

The BOJ initially envisaged plunges in market interest rates under the negative rate policy stimulating household consumption and corporate investment to pave the way for achieving its "price stability target" of 2%.

In fact, market rates have fallen sharply on a broad front. For example, the yield on 10-year government bonds, which serves as the benchmark of long-term interest rates, has fallen from 0.04% per annum to minus 0.1%. Prime lending rates on 10-year, fixed-rate mortgage loans have dropped to around 0.5%, resulting in an increase in loan refinancing.

Housing starts on rental units in the first half of 2016 increased some 9% from a year earlier to nearly 200,000 units due in part to active investment in apartments by wealthy people. A senior BOJ official said, "Negative rates are doing good for the housing sector."

Toyota Motor, Central Japan Railway and other companies have successively issued long-term corporate bonds of more than 10 years since this spring. Negative rates are underpinning capital spending as they have facilitated fundraising in the corporate sector, according to BOJ officials.

Limited effect

But negative rates' effects on the real economy are limited. Contrary to the BOJ's expectations, consumer prices show no sign of an upturn, although six months have passed since the negative rate strategy began.

There are two reasons for the current state of affairs. First, the strategy has failed to produce a virtuous cycle of a weaker yen and stronger stocks.

The BOJ's adoption of an "unprecedented" monetary relaxation in April 2013 and additional easing of credit in October 2014 was immediately followed by a plunge in the yen's value and steep rises in stock prices, resulting in earnings improvements at exporters and stimulating consumption through an expansion of household assets.

Negative rates contribute to the yen's depreciation as they widen gaps in interest rates between Japan and other countries.

But the BOJ launched the experiment with negative rates when the risk of economic slowdown in China and other countries was spreading. Amid a strong risk-averse mood across the world, investors did not turn to foreign currencies and stocks.

The BOJ's monetary easing brought "almost no effects" to the stock and foreign-exchange markets, said Minori Uchida, chief analyst at Bank of Tokyo-Mitsubishi UFJ.

A large number of manufacturers logged profit declines in the April-June period, due to the unexpectedly steep appreciation of the yen.

Amid the looser money policy's failure to weaken the yen and shore up stocks, households have grown concerned about falls in interest rates on government bonds and deposits and stepped back from spending.

As the second reason, the spread between deposit and loan interest rates, which is the fundamental source of profit for financial institutions, has narrowed. The nation's three megabanks -- Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group -- told the Financial Services Agency that the negative rate policy will eat into their profit by a total of 300 billion yen ($2.96 billion) or more in fiscal 2016 to March 31, 2017.

Even if banks cut their lending rates, loans do not increase amid widespread unease among businesses and households.

Now that both positive and negative effects of negative interest rates have come into the open, the BOJ needs to review how effective the policy is in pulling Japan out of deflation.

Review in September 

Faced with a slow rise in prices, the BOJ will review the effects of credit-easing measures in a comprehensive manner at its policy board meeting in September. A focal point will be the assessment of negative rates and the bank may resort to an additional easing of credit or amend its policy target, depending on results of the analysis.

At a press conference in late July, Kuroda denied that the negative rate policy had reached its limit. "There remains room for digging deeper," he stressed.

Many BOJ officials said an additional easing of credit will focus on negative rates. But as drawbacks of the policy have come to the fore, skepticism about deeper negative rates is emerging within the central bank.


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