Japan - It's a new dawn!

In a historic move, the Bank of Japan has ended the era of negative interest rates, after 8 years!

The decision came after a 7-2 majority vote to raise the overnight interest rate to 0% - 0.1% from a previous negative level of -0.1%.

What’s more interesting is that BoJ also discontinued Yield Curve Control (YCC) and stopped purchases of ETFs and REITs.

The Yield Curve Control was a cap on the 10-year Japanese Government Bond Yields, that was introduced to keep yields low enough to foster lending and consumption.

BoJ Governor Ueda said in the press conference that while they will not set an upper limit, they will respond flexibly if yields rise sharply. But, he further reiterated that the short-term policy rate will be used as the main tool, just like other central banks.

Quitting all these measures in one meeting has been quite a bold step from the BoJ, at a time when Governor Ueda has been very cautious about moving.

Nevertheless, as promised, the BoJ will continue their purchases of Japanese Government Bonds (JGBs) of about $40B (6T Yen) a month to keep conditions easy and encourage healthy consumption.

Market Reaction

It would seem that the market’s reaction to the change in negative interest rate policy and YCC, was priced in, to a large extent and instead, the continuation of bond buying is fueling equities while keeping the Yen weak.

The move in rates has settled down and actually has been anticlimactic. You would think, we’d be seeing green across this board.

This is exactly the reaction that the BoJ would’ve likely wanted and they got it!

After all, who cares about a slight increase in interest rates when there’s plenty of liquidity flowing in the markets? The rates at this stage are not likely to be high enough to even attract the funds from overseas back to the country just yet.

This keeps the Yen weak and therefore, would likely mean that inflation continues on the supply side until consumption can actually pick up.

But, the triple move leads me to believe that this is a one-and-done situation for now, and the BoJ will be in no rush to hike any further from here. We’re certainly not going to see a hiking cycle, the likes of which we’ve witnessed in the US or other developed countries.

What led to the decision?

The economy continues to remain weak and the strengthening of the Yen will lead to lower inflation levels. Japan has been importing inflation over the past 3 years and now, they need that source of inflation to be replaced by consumption and price increases from within the country.

The final decision was likely taken based on a series of events in the last few weeks which include:

• Final GDP growth coming in positive

• Discussions that Japan is finally out of deflation

• The Spring Wage Negotiations saw some of the largest pay increases since 1991 which could help increase domestic consumption.

During the press conference, Governor Ueda further confirmed that they are seeing the virtuous cycle of wages and consumption but still remain cautious about the SME wage rates.

Portfolio Moves

The reactions to these announcements were odd, to say the least. The USD/JPY hit 150 and the Nikkei crossed 40,000.

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