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Bank of Japan introduces negative interest rate policy

Japan's central bank shocked markets on 29th January with plans to effectively charge lenders to park their cash with it, ramping up a long-running battle to kickstart the world's number three economy.
The unprecedented decision to adopt a below-zero interest rate policy is the Bank of Japan's latest weapon as it looks to spur bank lending and drive up inflation. In response, the Nikkei stock index soared almost three percent as the yen plunged.

Under the plan, commercial lenders would now have pay to park cash at the Bank of Japan, giving them an incentive to boost lending, which policymakers hope would stoke economic growth. A similar below-zero policy was adopted by the European Central Bank in 2014, the first time by a major central bank.

All about Negative interest rate:
With the benchmark rate now at -0.1 per cent, it essentially means that the Bank of Japan will charge commercial banks 0.1 per cent on some of their deposits. According to a report in The Financial Times, negative interest rates will be adopted on the basis of a three-tier system. The current account that each financial institution maintains at the BOJ will be divided into three tiers, on which a positive, zero and negative interest rate will be applied.

In June 2014, the European Central Bank became the first major central bank to adopt negative interest rates. It charged banks 0.3 per cent for holding their cash overnight. Sweden, Denmark and Switzerland also have deposit rates below zero.

Bank of Japan seems to be worried about a slide into deflation territory. Consumer prices have remained stubbornly low, suggesting that demand continues to remain muted with consumers postponing purchases. This could derail the recovery.

According to analysts, collapsing inflation expectations is the key reason for the unexpected move. While the BOJ governor is previously reported to have said that it would hit the two per cent mark by 2016, Bank of Japan now forecasts core inflation to average 0.2 to 1.2 per cent between April 2016 and March 2017.

By charging banks for holding their money, Bank of Japan is hoping that it will spur banks to lend. Theoretically, if bank lending expands, it could boost consumption and investment, and push growth.

Lower rates could also help push down the Yen which could help boost Japanese exports. It might also trigger another round of competitive devaluations as countries try to increase their share in global trade. Many fear that in practice if banks make their customers pay to hold their money, it might lead to a situation where consumers hold on to cash.

It is equally possible that banks may not pass on the charge to their customers. According to economists at the Deutsche Bank, banks in Europe have not passed these costs onto customers and have preferred to lower their profit margin between lending and deposit rates.
Published date : 30 Jan 2016 05:30PM

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