Every time we’ve heard from BoJ officials over the past couple of years there has been one consistent message – imposing a negative interest rate on excess reserves was not on the agenda, not least since it could work against its asset purchase programme. And as recently as last week Kuroda was brazenly asserting that the BoJ was not seriously considering a cut in the interest rate paid on excess reserves (IOER). So, what lies behind today’s volte face, with the IOER cut from 10bps to -10bps?
Well, first, it needs to be understood that, overall, today’s announcement will not actually deliver a negative interest rate for banks’ excess reserves at the BoJ. Unlike the ECB, where a single rate applies to all excess reserves, the BoJ has introduced a multi-tiered system, closer to the arrangements in place in Sweden, Switzerland and Denmark. As a result, the impact on the average interest rate on bank reserves will be much weaker than the headline rate implies.
The BoJ’s three-tiered system will see each financial institution’s current account at the BoJ subject to three different interest rates, with:
- The amount equivalent to the average outstanding current account balance held throughout 2015 subject to an interest rate of +0.1%;
- The current account balances related to financial institutions’ required reserves and the BoJ’s provision of credit through its loan support programmes subject to an interest rate of 0.0%; and,
- Financial institutions’ additional current account balances going forward, which will respond closely to the additional proceeds of asset sales to the BoJ accrued under QQE, subject to an interest rate of -0.1%.
So, only the increase in banks’ current account balances from here on will attract the -10bps rate. That means that, on average over the coming year, more than two thirds of reserves will still earn 10bps, with a sizeable additional share to earn zero. And so, even assuming that the full proceeds of the BoJ’s asset purchases this year get recycled back into excess reserves at the central bank, on current plans the average interest rate to be applied on banks’ current account balances will be closer to +5bps than the headline -10bps figure.
Of course, over time, if the BoJ continues to purchase JGBs, and that results in a corresponding increase in current account balances, there would come a point at which the average rate on banks’ reserves will fall below zero. But on current purchase amounts that point would not be reached for about two years. And, with the BoJ saying that it will increase the amount of current account balances that will earn zero as the outstanding balance of current accounts increases as a result of its QQE programme, it is not certain that banks’ reserves at the BoJ will ever be subject to a negative average interest rate.
So, why do it at all? Well, clearly, with economic conditions having deteriorated recently, and with the BoJ’s updated economic projections seeing its core CPI forecast in FY16 cut by 0.6ppt to 0.8%Y/Y, the BoJ felt it needed to do something to prevent the improvement in underlying inflation being reversed. But there is a growing realisation at the BoJ that, given the needs of banks and other institutions to retain some JGBs for collateral and asset/liability matching purposes, the limits to further JGB purchases might not be too far off. Certainly, we would have doubted its ability to fulfil a larger target. So, the BoJ seems to have found itself between a rock and a hard place – up its target for JGB purchases and risk missing it, or introduce negative rates, threatening the achievement of even its current JGB purchase programme. It is therefore trying to steer a middle ground, introducing a negative interest rate on bank reserves that isn’t really a negative rate at all.
And once the dust settles on the “BoJ goes negative” headlines and the details of the announcement are digested, the eventual outcome of today’s announcement may be simply to reveal the diminishing options the BoJ finds itself with. Certainly, its inflation forecast of 1.8% in FY17, with Kuroda insisting that the BoJ’s 2% target would be met in the first half of FY17, seem preposterous, not least given that this coincides with the next scheduled consumption tax increase.
So, the pressure will remain on the BoJ to ease more. But we know now that having come to a fork in the road between more asset purchases or negative rates, it has taken the latter option. So, in due course, it is likely to feel obliged to push interest rates further into negative territory. But such a move may well have to be accompanied by a tapering of its asset purchase programme. In that respect, today’s announcement might be viewed as the first step to phasing in a new monetary policy framework centred on interest rates rather than one centred on asset purchases. And whether such a framework can sustain the success achieved so far by QQE in raising underlying inflation remains to be seen.