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Bank of Japan policymakers feared negative rates war, hit to bank profits

Bank of Japan stimulus could ignite a currency war

Policymakers at the Bank of Japan tussled over the decision to adopt negative interest rates, raising a slew of concerns ahead of a close vote, according to the official summary released Monday.

Blindsiding global financial markets on January 29, the BOJ adopted negative interest rates for the first time ever, buckling under pressure to revive growth in the world's third-largest economy. It was a close call, with five members voting for negative interest rates and four against the surprise move.

"I am concerned that the Bank's introduction of a negative interest rate could lead to a competition with central banks in other countries, which already have adopted negative interest rates, to lower interest rates deeper into negative territory," one member said, according to the summary of opinions at the monetary policy meeting.

Members submit a summary of their opinions to BOJ Governor Haruhiko Kuroda, who edits them before their public release. Individual members are not identified in the release.

Concerns over whether central banks would compete for the easiest policy aren't new, with many analysts raising the possibility over the past six months or more of a "currency war" to achieve the weakest exchange rate. A weaker currency offers countries benefits in the form of more competitive exports.

But the BOJ's move sparked talk that the U.S. Federal Reserve could consider negative rates if threats to U.S. growth increased, despite the fact the Fed enacted its first rate hike in nine years just two months ago.

The European Central Bank (ECB), meanwhile, already pays negative-0.30 percent on banks' overnight deposits, and on Feb. 5 the Czech central bank said that it had "seriously discussed" introducing negative rates.

Sparking a battle of decreasing interest rates was not the only concern expressed at the BOJ meeting.

The same, unnamed member also cautioned that the move would affect perceptions of the bank's quantitative easing program, which aims to boost the monetary base by 80 trillion yen ($682 billion) a year through purchases of Japan government bonds (JGB) and other assets, including exchange-traded funds (ETF).

"As medium- to long-term JGB yields become negative, there is an increasing risk that only the Bank may become the ultimate buyer of JGBs and that market participants will regard the Bank's JGB purchases as deficit-financing," the summary said.

Japan's government finances are notoriously deep in the red; gross government debt is around 250 percent of gross domestic product (GDP).

Other concerns were raised about how negative rates would affect the BOJ's JGB purchases, as well as the impact on the financial system as a whole.

"The introduction of a negative interest rate would cause the following problems: it would affect the stability of the Bank's JGB purchases, since it would reduce financial institutions' incentive for selling JGBs to the Bank, and it could lead to an increase in potential instability of the financial system as a result of further decreases in financial institutions' profitability," a member said. "This policy measure would only be appropriate in a crisis situation."

The negative-rate policy will likely hit banks' earnings. The new system, which takes effect in February, will subject the reserves banks park at the BOJ to a three-tier system of positive, zero or negative interest rates. In general, the BOJ will apply a rate of 0.1 percent to the average amount held in 2015, with a zero rate for required reserves and a negative 0.1 percent rate will take effect for any funds above those two amounts. Charging banks to hold their reserves will eat into their profits, unless they can lend out the funds profitably.

The multi-tier system for rates will avoid an "undue burden" on financial companies' earnings, a member said.

But there was some skepticism that the policy's objective of encouraging banks to both lower lending rates and lend more could be achieved.

"There is limited room for the private sector's borrowing rates to decline further in response to an additional decrease in JGB yields, and thus business fixed investment is unlikely to increase," one member said.

However, the move to lower rates into negative-land managed to win the day, if only by one vote.

A member noted that the BOJ wasn't headed into entirely uncharted territory and that it had gained "enough knowledge" about the policy from the experiences of European countries that had already adopted negative rates.

Another aim of Japan's negative rates appeared to be aimed at showing the central bank wasn't impotent despite being forced to push back its target date for achieving 2 percent inflation. The BOJ has repeatedly blamed drops in commodity prices for its inability to kickstart meaningful inflation in an economy that has long struggled with deflation.

The BOJ now forecasts core inflation to average 0.2-1.2 percent between April 2016 and March 2017. Kuroda had previously said he hoped to hit 2 percent inflation by late 2016, but markets are widely skeptical even of the delayed target dates.

The negative-rate policy "will enable the Bank to demonstrate that there is plenty of room for pursuing additional easing," a member said.

- Nyshka Chandran contributed to this article

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter