Bank of Japan surprises with negative interest rates

The BoJ said on Friday that it will apply a negative 0.1% to excess reserves financial institutions place at the bank with effect from 16 February.

The bank voted five to four in favour of the decision, which it attributed to declining oil prices and the slowdown in China.

At the same time, it left its bond and exchange-traded funds-buying programme unchanged.

"Recently, however, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy," the BOJ said in a statement.

"For these reasons, there is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected."

The BoJ added that it would cut interest rates further into negative territory if this was deemed necessary.

“While we saw a possibility of a rate cut, the introduction of negative rates at this juncture was a positive surprise,” Nomura said.

“To consider actions in the medium term, the composition of BoJ board will be worth monitoring,” said Nomura, noting that two of the four dissenters will retire this year.

“More dovish board members will likely be appointed by PM Abe, which will enable the BoJ to consider more aggressive cuts if necessary, in our view.”

Craig Erlam, senior market analyst at Oanda said the move by the BoJ was “the correct response given the extremely low levels of inflation and growth in the country, the latest decline in commodity prices and the added deflationary pressures that the stronger yen could bring”.

Did Kuroda really surprise markets?

In an interview with Bloomberg TV, approximately one week ago, at the World Economic Forum, in Davos, the BoJ governor appeared not to drop any hints that further stimulus was on the way.

However, some analysts were of the opinion that it was his usual ploy to try and surprise markets and thus obtain greater benefit from the move.

“Kuroda is trying hard to extinguish speculation for easing so that he can make the most of it,” Yasuhide Yajima, the chief Japan economist at NLI Research Institute, who correctly anticipated today´s decision along with Erlam, told Bloomberg on 24 January: “Make no mistake: He gave optimistic views even a few days before bolstering stimulus in 2014. What matters is the outlook, not the current situation, and the prospects for inflation in Japan worsened dramatically.”

"However, it may be a closer call than we previously thought. We believe the BoJ could even hint at an April move as early as next week, as ECB President Draghi appears to have done," economists at Barclays had predicted on 22 January.