The negative interest rate regime in Japan is likely to circumvent banks and target currency and market financing. According to Maxime Alimi, from Axa Investment Management, there are three main implications to this:
- The Bank of Japan has room to cut further and is likely to use it;
- Significant risks of financial market disruptions and
- Financial repression for institutional investors.
In their view, “the BoJ played a role in the recent market correction as it sharpened the market’s pessimistic assessment of central banks’ potency to address sluggish growth and inflation.” Japanese banks have, and will continue to have, only a very small share of their reserves effectively taxed, unlike in Europe, plus “banks are very unlikely to pass on negative rates to their clients either through deposits or loans.”
What is the point, then, of cutting interest rates into negative territory? The team believes that the BoJ is counting on non-bank channels to support the economy and borrowing condition, which include:
- Currency: lower policy interest rates still influence money market rates and therefore the relative carry of the yen compared to other currencies.
- Sovereign yield curve: lower short-term interest rates spread to longer-term yields via the expectation channel.
- Corporate bond yields: financing costs for corporates fall as a consequence of lower JGB yields as well as tighter spreads resulting from the search for yield.
- Floating-rate bank loans: a large share of mortgages and corporate bank loans are floating and use interbank market rates as benchmarks.
They also believe that given “deposit interest rates have a floor at zero, largely removing the risk of cash withdrawals, the BoJ has a lot of room to cut interest rates below the current -0.1%. They have effectively made the case that ‘there is no floor.'” As well as that with negative rates, the risk of disruptions and illiquidity is high and that the burden of negative interest rates will be mostly borne by institutional investors, which have to invest in debt securities.
“The BoJ is “fighting a war” against deflation and has repeatedly proven its commitment since early 2013. But this war has to be short in order to be won. This was true with QE, it becomes even more true with negative rates. This will require not only monetary policy to be effective but the other pillars of Abe’s policies to come to fruition soon. Otherwise, not only will the benefits of this ‘shock-and-awe’ strategy fade away, but associated risks will mount. More than ever, the clock is ticking for Abenomics,” he concludes.