The fallout from low interest rates (1)
Nope to NIRP
UNTIL this month bond traders were the most voluble complainers about the Bank of Japan’s vast programme of quantitative easing (creating money to buy bonds). The central bank’s interventions had slashed trading volumes in their market. But their gripes had a tiny audience and, understandably, received scant sympathy. Things have changed with the central bank’s new negative interest-rate policy (NIRP), which went into effect on February 16th. It has pummelled banks and spooked Mrs Watanabe, the archetypal Japanese saver. Fans of the new policy are hard to find.
For around two trading days after the BoJ announced on January 29th that some bank reserves would be charged -0.1%, financial markets responded as intended—the yen weakened and the Nikkei 225 share index rose. Then, with the European Central Bank hinting at an extension of its own negative-rate policy, investors sought safety in the yen, which rose sharply.
In turn that dragged down the stockmarket, since Japan’s exporting giants may earn less if their competitive position is eroded.
Even after a rally on February 15th, when the Nikkei rose by 7.2%, the stockmarket is down by 9.6% since the BoJ’s announcement of negative rates; the yen is 5.9% higher against the dollar. Stocks were not helped by news that GDP contracted by an annualised 1.4% in the fourth quarter, chiefly because of weak consumption.
The chief surprise for the BoJ was that banking stocks fell even faster than the overall market, with the drop coming close to 24%. The direct effect on banks’ profits is limited. For now, the central bank’s negative-rate policy applies to only ¥23 trillion ($200 billion) out of the ¥253 trillion that banks have parked with it. A further ¥24 trillion will earn 0%, and the rest will continue to earn 0.1%. But the BoJ may not have thought as much about the indirect effect on their business models, says Naohiko Baba of Goldman Sachs.
Sharply lower long-term interest rates—the ten-year government-bond yield briefly dipped into minus territory (see chart), alongside overnight interbank rates—mean a sharp squeeze on net interest margins for all banks when profits from lending have already gone down. There is little room to shield margins. Deposit rates are wafer-thin; banks are unlikely to charge retail customers for parking their funds.
Standard & Poor’s, a rating agency, expects profits at the five largest Japanese banks to fall by 8% over the next year or so and by 15% at regional banks, which are more dependent on their traditional lending businesses. A profits crisis among Japan’s 100-odd small local lenders may be just what the regulator ordered, since it is trying to consolidate them, but it probably had a smoother process in mind.
If the BoJ ventures further into negative territory in order to reach its target for sustained inflation of 2%, the impact on big banks could become too pronounced for comfort. The governor, Haruhiko Kuroda, would probably like to bring rates to levels similar to those of some European central banks, at perhaps -0.5% or lower. Negative rates are a potent new means of easing when the BoJ may face limits on expanding its bond purchases from its current ¥80 trillion a year. It now owns around a third of Japanese government bonds. Expanding purchases to around ¥100 trillion is probably as far as it can go.
Japan’s big banks have the capital and profits to withstand a squeeze. If, as the BoJ wishes, they are prompted to expand bargain-basement loans to companies and consumers, they will help stimulate the economy. Several are already lowering mortgage rates, sparking hopes for further house-price rises. Yet banking chiefs, who have until now supported the BoJ’s monetary easing, are likely to use their considerable influence to lobby against a further descent into the red.
Many ordinary savers, meanwhile, view the central bank’s move as a portent of unstable times.
Elderly deposit customers remember the time, after the second world war, when the government restricted cash withdrawals from banks and taxed deposits to pay off debts, notes Izuru Kato of Totan Research in Tokyo. Shopping malls in the capital are urging the merits of safety deposit boxes just in case commercial banks do impose negative rates, and they are selling well. A handful of local banks, such as Onga Shinkin Bank in Fukuoka prefecture, have defied the central bank with a rise in deposit rates to reassure their nervous customers.
Given the volatility associated with the introduction of negative rates, the BoJ has indicated that it will gauge the market’s mood before lowering them further. The turmoil is also prompting questions about the policies of Shinzo Abe, the prime minister. If monetary easing is reaching its limits, fiscal policy may be needed to try to revive the economy. Mr Abe’s advisers are once again strongly urging the postponement of a second increase in the consumption tax, or VAT, which is due in April 2017.
The rise has already been delayed once. Hawks at the Ministry of Finance are fighting hard against the possibility. But such a step would please almost everyone else, unlike negative rates.