Chart Of The Week: Japan’s Move From ZIRP To NIRP Doing More Harm Than Good

The Bank of Japan moved to a policy of negative interest rates in the hope of boosting asset prices and depreciating the currency. To date this has been wholly counterproductive – the yen has strengthened and equities, particularly in the banking sector, have tumbled.

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In the past, it was believed that implementing a Negative Interest Rate Policy (NIRP) was complicated by the presence of a readily-available alternative asset that yields a preferable rate of return — cash! However, Japan’s tiered interest rate structure neatly avoids that problem, with the portion of commercial banks’ reserves that attract a negative rate of interest rising in line with banks’ cash holdings. With no means to circumvent the negative rate of interest, there is no Zero Lower Bound.

It is hoped that the penalisation of banks’ reserves will encourage them to diversify into riskier, higher yielding assets. By doing so, banks will be compensated for the squeeze on their profit margins caused by the negative deposit rate. This portfolio rebalancing effect was cited in the Bank’s ‘Summary of Opinions at the Monetary Policy Meeting’ as one of the benefits of cutting the interest rate.

Lowering interest rates was also considered an effective way to depreciate the currency. Indeed, this was a key reason behind the imposition of a NIRP in Sweden, Denmark and Switzerland, as their central banks attempted to prevent rapid currency appreciation against a weakening euro. Unfortunately, the Bank of Japan has been unsuccessful in this endeavour.

To date, the Bank of Japan’s decision to join the negative rates club has been counterproductive – the yen has strengthened and equities have tumbled with markets concerned about the potential for the policy to harm bank profitability.