Bank Of Japan Abandons Negative Interest Rate

Japan's central bank took significant steps on Tuesday to begin unwinding one of the most aggressive monetary easing programs globally. After announcing its first interest rate increase in 17 years, the Bank of Japan (BoJ) disclosed its decision to adjust its short-term policy rate from -0.1 per cent to a range between zero and 0.1 per cent.

In its statement, the BoJ indicated that it evaluated the relationship between wages and prices, concluding that achieving the price stability target of two percent seemed feasible in a sustainable manner by the end of the projection period outlined in the January 2024 Outlook Report.

Moreover, the central bank announced the cessation of other unconventional policies, including its yield curve control programme on bonds and the purchase of risk assets like exchange-traded funds (ETFs) and Japan real estate investment trusts.

While central banks globally increased rates to combat soaring inflation following Russia's 2022 invasion of Ukraine, Japan, mindful of its past "lost decades" of stagnation and deflation, had maintained its main rate in negative territory since 2016, with the last hike occurring in 2007.

The decision to raise rates implies that loans will become costlier for both consumers and businesses. Additionally, servicing Japan's substantial national debt, which stands at approximately 260 per cent of national output, will become more expensive.

Negative interest rates were initially implemented to encourage banks to lend to businesses, thus stimulating economic growth and inflation. Furthermore, the BoJ has injected significant liquidity into the financial system by purchasing bonds and other assets.

This policy has contributed to a notable depreciation of the yen against the dollar, benefiting exporters but adversely impacting consumers due to increased import costs. Inflation has hovered at or above the BoJ's two percent target for nearly two years.

However, despite minor adjustments, such as increased flexibility regarding its target range for bond yields, the primary interest rate remained negative. The BoJ awaited stronger evidence of a "virtuous cycle" characterised by rising wages and demand-driven inflation.

The recent wage hike secured by Japan's largest trade union, marking the most substantial increase since 1991, seems to fulfill the BoJ's requirements for sustaining domestic inflation at two percent.

In addition to adjusting interest rates, the BoJ is reportedly poised to scrap other unconventional measures, including its yield curve control programme and the purchase of risk assets.

While there is trust in the BoJ's decision-making, an overly aggressive approach could attract large capital inflows to Japanese assets, potentially destabilising financial markets.