The Bank of Japan has begun paying banks for the privilege of lending them cash in a sign the central bank is reaching the limits of its power to reflate the economy, although it may soon be forced to pump yet more money into the financial system.
Negative yields are more than a footnote in the BOJ's unprecedented "quantitative and qualitative easing" (QQE) policy. They show that Governor Haruhiko Kuroda's 18-month-old monetary experiment is struggling barely halfway to its 2 percent inflation goal.
"Practically, this is not a policy that you can maintain for a long time," said Tomohiro Miyasaka, fixed-income strategist at Credit Suisse. "The BOJ is absorbing bills and bonds from markets so much that one day there could be no bills and bonds left to buy."
The BOJ already buys most of the government's issuance of debt. Last week, it paid financial institutions more for three-month, and then six-month, government debt than it will receive when the bills are redeemed, traders said. This force-feeding of cash into the banking system pushed the three-month yield as low as -0.015 percent and the six-month to -0.020 percent.
Banks holding debt to dress up their quarter-ending accounts partly explains the swing in rates. But the fact that a seasonal factor can have such an impact shows just how little appetite there is for the cash the central bank is injecting into the economy, traders said.
The anomaly may spread to one-year bills as soon as Wednesday, when a government debt auction is held.
"I think the one-year bill yield could fall below zero, given tight demand in markets. The BOJ will have to keep buying short-term bills," said Miyasaka, to meet its cash-infusion targets.
Debt specialists say it is highly unlikely negative rates could spread to ordinary savers' bank deposits, but the BOJ's pursuit of assets at any price could feed criticism it is subsidizing banks and bankrolling the government's massive debt.
Kuroda launched the wave of monetary stimulus in April 2013, pledging to double Japan's base money via aggressive asset purchases to stoke 2 percent inflation in about two years.
Early results looked promising. The it printed pushed down the currency's value, helped arrest a 15-year slide in consumer prices and boosted both corporate profits and the Tokyo stock market.
But even as the BOJ buys 70 percent of new government bond issuance, inflation is stuck around 1.3 percent, and the world's third-biggest economy is sputtering after an April sales-tax increase hit consumption more than the authorities had expected.
The BOJ acknowledges achieving 2 percent inflation - rarely seen even during Japan's bubble years - will be difficult.
BOJ officials will not confirm that the central bank accepted negative rates on some of its 750 billion yen ($7 billion) of market-funding operations last week. It says it can not disclose individual transactions.
But Kuroda said he saw no "serious problem".
"We're always watching markets carefully and I don't see any signs that we're having more difficulty buying (debt). We're looking at markets calmly," Kuroda told a news conference on Tuesday.
He has maintained that policy is on track and the central bank has the financial ammunition it needs if it decided to expand the stimulus program, although now was not the time to discuss adjusting policy.
"I don't think there are limits to what additional steps we can take," Kuroda told a television interviewer last week. "If necessary, we have room to take appropriate measures," he said.
Matter of time
Financial markets think otherwise. No economists in Reuters monthly surveys since the policy began have forecast inflation would hit Kuroda's target. In the latest survey last month, economists forecast just 1.2 percent inflation through the fiscal year to March 2016.
They think it is just a matter of time before the BOJ eases further, either later this year or in January or later.
"Sooner or later, the BOJ will have to think about what it will do next year," said Hidenori Suezawa, financial market analyst at SMBC Nikko Securities in Tokyo.
Speculation is rising the central bank will ease policy and the Finance Ministry will authorize another burst of government spending to boost the economy, especially as Prime Minister Shinzo Abe faces a decision around December on whether to proceed with a further sales-tax hike next year.
Kuroda, a former top Finance Ministry official, has expressed support for the tax hike as a step toward curbing the nation's high public debt. Abe on Sunday said he remains "neutral" on his looming decision.
Under the stimulus plan, the BOJ plans to buy some 50 trillion yen in long-term Japanese government bonds (JGBs) this year, plus 20 trillion yen in mostly short-term securities.
If the BOJ was to expand its stimulus, the only market big enough to absorb the cash would be the JGB market, traders say.
Benefits of negative yields?
In order to press on with its easing, the BOJ appears ready to continue accepting negative yields. And yet the benefits for such exertions are unclear.
In addition to stalled inflation, banks have not revved up lending because borrowing demand is weak. Banks, particularly ones outside major cities, have made only limited progress in rebalancing portfolios out of JGBs to more productive assets.
Even with interest rates low, bank lending growth of about 2.3 percent from a year earlier is little changed from the start of the BOJ's easing campaign.
Some BOJ policymakers are beginning to warn of the rising costs of maintaining the policy and the diminishing returns if it was expanded.
Takahide Kiuchi, among those in the nine-member board most skeptical of the stimulus plan, argues the policy should be ended in two years for a review. Kiuchi is against a further easing.
"There are significantly big potential risks to QQE such as the difficulty of normalizing monetary policy and the chance of heightening market views the BOJ is monetizing public debt," Kiuchi said in a recent speech.
"If the current massive stimulus program is prolonged or strengthened, such drawbacks will exceed the costs," he said. "That risks threatening economic stability in the long run."