Michael Chen

March 11, 2024 - 04:03 am

Bank of Japan Poised to End Negative Interest Rates, Marking End of Global Central Banks' Unconventional Policy Era

(Bloomberg) – The Bank of Japan stands on the precipice of a significant policy reversal as forecasts mount in anticipation of the Bank abandoning the world's last negative interest rate in the near future. This change signals the end to a global monetary policy paradigm that has been both daring and controversial.

Governor Kazuo Ueda is poised to elevate the short-term rate from its current -0.1%—perhaps as early as next week or potentially in April—marking what would be Japan's first interest rate hike since 2007. Economists and bond traders alike are awaiting this pivotal decision with bated breath.

As the Bank of Japan readies itself for this shift, it will represent a pivotal return to more conventional policymaking. Over the past several decades, Japan's central bank has engaged in aggressive quantitative easing, acquiring an extensive portfolio of bonds and equities. This approach has seen its balance sheet balloon to an extraordinary 127% of annual economic output. The expansive stimulation and the introduction of negative interest rates served to devalue the yen and deter deeper deflationary spirals. It wasn't, however, until supply disruptions wrought by the COVID-19 pandemic and the ongoing conflict between Russia and Ukraine, that inflation consistently rose above the 2% threshold.

For the international community, this move is more than a policy adjustment; it symbolizes the conclusion of an era marked by negative interest rates—a bold strategy for battling deflation, which was not only deployed by the Bank of Japan but also by the European Central Bank and several of its European counterparts during the 2010s. The method yielded mixed results and sparked debate, with critics positing stress on banks and fixed-income earners. In Japan, opinions remain divided regarding the efficacy of negative rates.

“The negative rate did nothing, nothing at all” to drive inflation, contends Kazuo Momma, a former Bank of Japan executive director responsible for monetary policy. Momma argues that Japan's inflation trends were mostly influenced by international pricing pressures, rather than domestic policy measures.

A New Dawn for Japan's Monetary Policy

Beginning its journey in Denmark before spreading to the financial landscapes of Switzerland, Sweden, and the euro zone, negative rates served varied purposes—from curbing considerable capital inflows to the Swiss franc to stimulating price growth in the euro zone amid the sovereign debt crisis.

The Bank of Japan, after grappling with over a decade of deflation, took a decisive leap into negative territory in 2016, surprising many just days after then-Governor Haruhiko Kuroda had denied any plans for such a move. "It was very impactful," reflects Hiroshi Yoshikawa, an emeritus professor of economics at the University of Tokyo and former adviser to the prime minister's economic council. The policy shift underscored the severity of Japan's economic woes to the public.

At the time, Governor Kuroda suggested that rates could be pushed even lower if necessary. Yet, public backlash, coupled with disapproval from the banking sector—whose profit margins were being compressed—and from pension and insurance fund managers forced to seek overseas investments with adequate returns, anchored the interest rate from dropping further. Mere months into the policy's implementation, the Bank of Japan called for a comprehensive policy review to stabilize bond yields while maintaining the negative rate.

The Global Negative Rates Experiment and Its Mixed Outcomes

Sub-zero interest rates weren't unique to Japan; the experiment continued internationally. The volume of bonds with negative yields reached an astonishing $18.4 trillion by late 2020, as reported by Bloomberg's Global Aggregate Index. However, as inflation began to awaken from its slumber, European central banks gradually exited the realm of negative rates. The Swiss National Bank's decision in September 2022 effectively left the Bank of Japan as the last stronghold of sub-zero rates.

But opinions on the efficacy of the policy remain diverse. The European Central Bank champions negative rates, citing research that credits them with bolstering bank lending, enhancing policy transmission into the financial system, stimulating economic activity, and elevating inflation rates. Thomas Jordan, chief of the Swiss central bank, believes that the policy "has proved its worth" and stands ready to employ it again as needed. Conversely, Sweden's Riksbank departed from negative rates in late 2019, citing adverse impacts on its financial system.

The United States' Federal Reserve steered clear of negative rates, with its own rates only dipping to a range of 0 to 0.25% in March 2020 amidst the COVID-19 crisis. Fed researchers suggest that while negative rates can be beneficial in the short term, overextended implementation could prove "counterproductive."