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Less Than Zero

The Bank of Japan has taken key interest rates into negative territory for the first time, in its latest move to fight deflation and jumpstart economic growth. What does it mean for Japan and global markets?

Japan is determined. The Bank of Japan has again shown flexibility and grit in retaining and extending the gains made in the fight against deflation. Now, facing global market disruptions and economic jitters in major export markets, Japan has taken new measures.

On Friday, Jan 29, 2016, the BoJ unexpectedly announced that it would adopt a multitiered interest-rate regime, and that rates on one of those tiers would be negative. This -0.1% rate will apply to new deposits by financial institutions at the BoJ.

In effect, financial institutions will pay a fee on increments to reserve deposits. The hope is that they will lend more, circulating cheap credit to spur business investment and household spending, create jobs, stimulate the real-estate sector, and build domestic demand to revive growth momentum.

However, the new demonstration of resolve by the BoJ should help return inflation expectations to an upward path, and thus spur demand. The other key result: The yen will likely settle within a range of ¥115-¥125 against the dollar, thus, stabilizing earning expectations and export prospects.

This is a significant move, make no mistake. It comes on top of three years of “quantitative easing” involving the BoJ purchase of Japanese government bonds to flatten yield curves and bring down real interest rates, when keeping nominal rates at zero proved insufficient within the hoped-for time-frame. It also comes as Japanese Prime Minister Shinzo Abe’s economic reform program, often called “Abenomics,” faces new hurdles in light of the sudden change of the economic minister, despite some significant success in fiscal reform and growth strategy.

The BoJ is not alone in negative-interest-rate territory. Denmark, Sweden, Switzerland, and the European Central Bank have all adopted some form of negative-rate policy over the past year to fight “lowflation”—persistently low levels of inflation—or the outright danger of deflation, especially as oil prices have declined. The BoJ, which has set its inflation target for 2%, faces the same issue, amid fears of stalled progress against deflation in light of recent yen movements and demand concerns.

The BoJ’s new negative rates, on top of the ECB’s recent talk of expanding its bond-purchasing stimulus program, also widens the monetary policy gap with the Federal Reserve, which kicked off its campaign to get US rates off the zero lower bound in mid-December. With US fourth-quarter 2015  GDP reported at 0.7% on Friday, Jan 29th, the Fed seems even less likely now to move aggressively to lift US rates this year.

For more Morgan Stanley Research on the Japanese economy, interest rates and markets, ask your Morgan Stanley representative or a Financial Advisor for the full report, “BoJ Surprise: Implications for Macro, Equities, Fixed Income and Foreign Exchange” (Jan 29, 2016). Plus, more of our latest Ideas.

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