Central Banks

BOJ board among those surprised by negative interest rate plan

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Just days before the Bank of Japan stunned financial markets with its radical adoption of negative interest rates, members of the central bank's own policy board had also been taken by surprise by the move.

Most of the nine board members were only told of the scheme in the week leading up to last Friday's rate review, according to interviews with more than a dozen officials familiar with the deliberations.

The startling speed and secrecy with which such a major policy shift was executed suggest its intent was more about delivering a shock to markets that would weaken the yen, than about maximising the stimulative impact of further easing.

That would be in keeping with the single-minded style of central bank Governor Haruhiko Kuroda, people who know him well or have worked with him say, but could risk entrenching divisions between BOJ policymakers.

"If you're a board member, you're told about the plan at the last minute," said a former board member, speaking on condition of anonymity. "It's hard to argue against it or draft a counter proposal when there's so little time left."

The BOJ declined to comment on the decision-making process.

Kuroda had been saying for months that taking rates below zero was not a timely option, a position he had repeated as recently as Jan. 21.

Bank of Japan (BOJ) Governor Haruhiko Kuroda speaks next to a panel to explain his policy during a news conference at the BOJ headquarters in Tokyo, Japan, January 29, 2016.
Cramer: The Bank of Japan's move is bad for us

But the global market turbulence that greeted the start of 2016 had been threatening two planks of Prime Minister Shinzo Abe's reflationary agenda - rising asset prices and a cheap yen.

Before leaving for the annual World Economic Forum in Davos on Jan. 22, Kuroda instructed his staff to come up with options for further easing of the BOJ's already ultra-loose policy, and report back to him when he returned to Tokyo three days later.

Expanding the bank's massive asset purchasing programme, known as "quantitative and qualitative easing" (QQE), by 10-20 trillion yen ($83-$167 billion) was one option, sources said, though it was quickly ruled out as too weak to shock markets.

Something more arresting was needed, and few investors were predicting negative rates.

"The key was to show people that the BOJ will really do anything to achieve 2 percent inflation," said a BOJ official.

The complex plan, formulated by four top officials from the monetary affairs department, drew on studies of negative interest rate policies in Denmark, Switzerland and Sweden.

By charging interest on just a fraction of banks' deposits with the BOJ, they hoped to ease the pain on financial institutions and get around one of the big problems of twinning negative interest rates with QQE - that the central bank is force-feeding lenders cash it then penalises them for holding.

On his return, Kuroda gave the go-ahead, favouring the idea that combining negative rates and money-printing would dispel market views he was running out of ammunition.

Red lights flashing

At the BOJ's headquarters in Tokyo, monitoring signs alert staff with a flashing red light to show when a board member has visitors in their rooms on the eighth floor.

Haruhiko Kuroda, governor of the Bank of Japan (BOJ)
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In the days leading up to the Jan. 29 meeting, the lights for the three swing voters on the divided board glowed red for hours, as a handful of top officials lobbied furiously for the plan.

Kuroda could count on his two deputies to support him.

Three other board members - market economists Takehiro Sato, Takahide Kiuchi and former banker Koji Ishida - were known to be deeply suspicious of QQE's effectiveness and opposed to more easing.

The lobbying effort therefore focused on the remaining board members - academics Yutaka Harada and Sayuri Shirai, and former Toyota Motor executive Yukitoshi Funo.

As Japanese stocks fell and the currency rose on safe-haven demand, the senior BOJ officials told waverers that failing to act could hurt business sentiment and discourage firms from raising wages, said sources familiar with the discussions.

Already worried about weak consumption, Harada consented.

But Shirai - once a strong advocate of QQE - has grown doubtful of Kuroda's argument that by aggressively printing money the BOJ can spur public expectations that prices will rise. It soon became clear she would vote against.

The fate of the plan thus rested with Funo, a newcomer to the board whose vote was hard to predict.

The BoJ is uncomfortable with markets: Economist
The BoJ is uncomfortable with markets: Economist

A week before the rate review, Funo had said he did not think additional stimulus was needed now. But the ex-Toyota man, hand-picked by the government in the hope he would support its radical "Abenomics" policies to beat deflation, also had no strong reason to block Kuroda.

"Funo really held the key to Friday's decision. Now we know he'll probably vote with Kuroda if the BOJ were to ease again," said one source familiar with the bank's thinking.

Unintended consequences

When the board met, Kuroda likely read a statement to members huddled around a round table, sources who know how policy-setting meetings are organised said, arguing the bank needed to act to pre-empt risks from unstable global markets.

The dissenters then made their counter-arguments.

Ishida said that pushing down already low bond yields would do little for the economy, according to the views outlined in the policy statement released after the decision.

Shirai, whose term expires in March, said the scheme was too complicated and could confuse markets, and also worried it could be interpreted as exposing the limits of QQE.

What does BOJ hope to achieve with new policy?
What does BOJ hope to achieve with new policy?

At the end of the meeting, which lasted a fairly typical four hours, Kuroda's proposal passed by a 5-4 vote.

Top bank officials were relieved to see the yen weaken after the announcement.

"It's typical Kuroda style," said Eisuke Sakakibara, who as a senior finance ministry official worked with Kuroda to contain sharp yen swings in the late 1990s.

"What's very important is to spring a surprise and to appear unwavering in your policy direction. That's how you get the maximum effect on markets."

But work on the plan was done so hastily that some operational details were not hammered out in time for the decision.

Critics say Kuroda has failed to explain why combining QQE and negative rates would spur public expectations of future price rises.

Some policymakers also worry of unintended consequences.

Banks may keep cash holdings to a bare minimum to avoid being penalised, which would expose them to the risk of a sudden liquidity squeeze, some of them say.

"There could be accidents, where money gets clogged," said one official. "Nobody really knows what could happen."

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