BoJ monetary policy assessment could tweak the tiering system to alleviate the negative rate burden

The Bank of Japan (BoJ) will announce the result of its monetary policy assessment, on March 19th. This assessment is important as the mandate given to the BoJ, namely that inflation reaches 2%, has not been achieved. On the contrary, and in spite of the massive asset purchases and the negative interest rate policy, inflation has remained subdued. In fact, Japan’s core CPI has remained in the negative territory since last August. Furthermore, the negative rate policy has weakened the monetary transmission mechanism and also hampered bank profitability further by pushing the interest margin even lower.

In this note, we offer our own views on actions that the BoJ may take as a result of the ongoing assessment. First of all, an instrument at the BoJ’s hand to address some of the problems created from its strategy, and in particular the introduction of negative interest rates, is to revise the tiering system. Because banks in particular regional and foreign banks have been suffering from negative interest rates in their reserves with the BoJ, the latter could expand its Basic Balance where a positive interest rate of +0.1% is applied. This would alleviate the adverse effect from the negative rate policy. 

As a second measure, the BoJ could introduce a subsidized loan program to support regional banks with business consolidation and to help the Tohoku region which was affected by a large earthquake in mid-February.

A third measure would be for the BoJ to expand the fluctuation band for the 10-year JGB yield from the current 0.2%, so as to offer more flexibility within the policy of yield curve control. One reason why this flexibility is needed now more than ever is the quick steepening of the US curve which might have a bearing on that of Japan. Finally, if the Yen were to appreciate even more, which could happen in the event of an inflationary scare in the US and a related depreciation of the USD, more abrupt measures may be needed to deal which such sudden appreciation but it seems unlikely they will include a new cut in interest rates to an even more negative scenario.

All in all, supporting regional banks and regaining flexibility seem key issues to tackle in the BoJ’s ongoing assessment.

Full report available for NATIXIS clients.