Japan ends negative rates

The Bank of Japan ended seventeen years of unconventional policy on 19 March. It raised its overnight rate from minus 0.1 per cent to a range of zero to 0.1 per cent, scrapped Yield Curve Control and stopped buying ETFs. Governor Kazuo Ueda has taken the world's last negative-rate central bank back to orthodoxy.

How Japan got here

The experiment was built up in layers. The BoJ began buying exchange-traded funds in 2010, launched its programme of massive bond purchases under Haruhiko Kuroda in April 2013, cut its short-term rate below zero in January 2016, and in September of that year began capping ten-year government bond yields. Each step was meant to end Japan's long bout of falling prices by convincing households and firms that inflation was coming. For most of a decade, inflation stayed stubbornly below the bank's 2 per cent target.

What changed was imported inflation. The rise in global energy and food prices after 2021, amplified by a sharp fall in the yen, pushed Japanese consumer prices above 2 per cent for the first time in years and kept them there. The BoJ was sceptical at first, arguing that price rises driven by import costs would fade. It needed evidence that wages were rising too, so that inflation would sustain itself rather than simply squeeze households.

Wages opened the door

This year's Shunto wage talks produced rises of more than five per cent, enough to satisfy the BoJ's test for a sustainable cycle of wages and prices. The bank moved with great caution all the same, and promised to keep conditions accommodative. Leaving negative rates behind is a symbolic step. Japan is still a long way from tight money.

The details make the caution plain. The bank said it would keep buying government bonds at roughly the same pace as before, even without a formal yield cap, and would step in if long-term yields rose sharply. It gave no signal of a timetable for further increases. Markets took the message: the yen weakened after the announcement, since the gap between Japanese rates and those in America and Europe remains enormous.

Past exits went badly

The BoJ has tried to normalise before. In August 2000 it ended its zero-interest-rate policy, only to reverse course within months as the dotcom bust pushed Japan back into recession. In 2006 it ended quantitative easing and raised rates twice, the second time in February 2007, which is the increase this move finally follows. The global financial crisis then forced it back to zero. Both episodes reinforced a view within the bank that premature tightening could lock in deflation, which helps explain why Ueda moved so slowly.

Winners and losers

Japanese banks are the clearest winners. Negative rates squeezed their lending margins for eight years, especially for regional banks with few other sources of income, and even a small positive rate lets them earn more on deposits parked at the central bank. Savers, who have earned almost nothing on deposits for a generation, will see a token improvement. Borrowers with floating-rate mortgages, which make up most new home loans in Japan, face slightly higher payments, though the increase is tiny.

The government is the biggest potential loser. Japan has the largest public debt in the rich world relative to the size of its economy, and the BoJ owns roughly half of the government bonds in issue. As rates rise, the interest bill will climb, slowly at first because much of the debt is locked in at low fixed rates, and faster as it is refinanced.

The carry trade stays

For global markets, the key question is the yen carry trade, in which investors borrow cheaply in yen to invest in higher-yielding assets abroad. A move from minus 0.1 per cent to between zero and 0.1 per cent barely changes its arithmetic. With American policy rates above 5 per cent, the incentive to borrow in yen remains strong. Only a sustained series of increases, or a sharp fall in foreign rates, would force a large unwinding.

Long-term yields barely moved. The ten-year government bond yield stayed well below 1 per cent after the announcement, because the bank's continued purchases leave it the dominant buyer and investors had anticipated the change for months. Life insurers and pension funds, which moved money abroad in search of yield, have little reason yet to bring it home. That matters for the rest of the world, since Japanese institutions are among the largest foreign holders of American and European bonds.

The case for faster tightening

Some economists argue that the BoJ is moving too slowly. Inflation has been above target for nearly two years, wages are now rising at their fastest pace in decades, and a weak yen keeps import prices high, hurting households. On this view, the bank risks falling behind the curve as other central banks did in 2021. The counterargument is that Japan's underlying inflation, excluding import costs, is still fragile, and the bank would rather be late than repeat the mistakes of 2000 and 2006. The Fed's decision on 20 March and its projections for American rates will shape the yen's next move, and the BoJ's April outlook report will show how quickly it expects inflation to settle.

The world's last negative policy rate is gone, closing a seventeen-year experiment. Further BoJ increases will probably be small and slow, so borrowing in yen will stay cheap for some time yet, and the carry trade will remain intact for at least the rest of this year.