In a surprise move, Japan cut interest rates to minus 0.1% on last Friday. Charging banks for the privilege of parking some of their excess funds was an unexpected and unprecedented move by the Bank of Japan. It is designed to encourage them to use their money reserves to lend to businesses in an attempt to counter Japan’s economic stagnation.
Inflation in Japan is running close to zero because of slumping oil prices. The central bank noted that the Japanese economy has recovered modestly with underlying inflation picking up, along with spending by companies and households. The eurozone has negative interest rates, but this is first time for Japanese economy. BOJ’s negative rates will reduce the profitability of the banking system, particularly the weaker and politically sensitive regional banks.
Japan adopts negative interest rate – Reasons
Negative rates are aimed at achieving the government’s 2% inflation target as early as possible. With minus interest rate, Bank of Japan now forecasts core inflation to average 0.2 to 1.2 percent between April 2016 and March 2017. Consumer prices have been remaining at very low rate since the drop of oil prices. When the news came out, share market – benchmark Nikkei – shooting up as much as 3 percent.
Existing reserves, which now total a record 220 trillion Yen($1.8 trillion), will continue earning 0.1%. The yen fell along with bond yields on the news. Another problem is that China’s weaker growth and global market hesitations have dented corporate Japan’s willingness to raise base salaries.
Japan’s largest export partners include the US, China, Australia, South Korea and Thailand, while its foreign investment is mainly in the US, China, UK and Singapore. Recently, all of these partners have been struggling with diminished prospects and growth rate. If Japan is swept by a crisis, its trade and investment partners will suffer heavy damage.
Bank of Japan Governor Haruhiko Kuroda said that the decision to introduce negative rates was meant to limit the risk that global conditions. Risks were growing due to the slowdown in the Chinese, emerging and resource-producing countries, which has caused volatility and instability in financial markets since the beginning of the year.