# What the End of Japan’s Negative Interest Rates Means

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 29 Mar 2024, 14 min.

Audio: https://traffic.megaphone.fm/APO2386545634.mp3

Send us a textJapan’s central bank raised interest rates last week for the first time in seventeen years, ending the world’s only remaining negative interest rate regime. The Bank of Japan also abandoned its yield curve control policy which has been in place since 2016, which saw it buying Japanese government bonds to keep longer term interest rates from rising. It has however maintained bond buying at the same pace for now.Patrick's Books:Statistics For The Trading Floor: https:/...

## Transcript

[0:00] Hello and welcome you are listening to Patrick Boyle on
[0:03] Finance, a podcast exploring ideas from quantitative finance,
[0:08] examining events occurring in markets right now and financial
[0:11] history to see what lessons can be taken away, including
[0:15] interviews with some of the most interesting people in the world
[0:18] of finance. To learn more about the podcast,
[0:20] visit on finance.org. Japan's central bank.
[0:29] Raised interest rates last week for the first time in 17.
[0:32] Years ending. The world's only remaining
[0:35] negative interest rate regime, the.
[0:37] Bank of Japan also abandoned. Its yield curve control policy.
[0:42] Which has been in place since 2016, which saw it buying.
[0:46] Japanese government. Bonds to Keep?
[0:48] Longer term interest rates from rising.
[0:51] It has. However, maintained bond buying
[0:54] at the same pace for now if Japanese rates were to continue
[0:58] to rise. It could have.
[1:00] Global repercussions? As the yen stability and low.
[1:03] Interest rates have given it a role in international finance.
[1:07] That might be about to change negative.
[1:10] Interest rates are when central banks require their
[1:13] counterparties to. Pay to.
[1:15] Store their excess cash at the institution.
[1:19] Following a seven to two vote last week, it was announced that
[1:23] the central bank would guide Japan's.
[1:25] Overnight interest rate to a range of about 0 to 0.1%.
[1:31] Obviously, this is not a huge rate hike.
[1:34] The prior benchmark rate. Had been. -0.1% It's maybe more
[1:39] important symbolically than anything else.
[1:43] Japan has a long. History of Central.
[1:45] Banking innovations. Or.
[1:47] Unconventional monetary. Policies which were introduced
[1:51] after the Japanese asset price bubble burst in the 19. 90s
[1:56] while Japan was not the. First country to introduce
[1:59] negative interest rates that honour goes to.
[2:02] Sweden it. Was the first country to
[2:04] introduce 0 interest rates in 1999.
[2:09] The Bank of Japan also. Pioneered asset purchase
[2:12] programs, known as. Quantitative easing along with
[2:15] the. Yield curve control policy.
[2:18] Both of which became widely used.
[2:20] By central banks around the world in the wake.
[2:23] Of the global financial. Crisis the.
[2:26] Bank of Japan went. A bit further than other central
[2:29] banks buying up stock market funds and real estate linked
[2:34] securities in what it referred to as qualitative easing the
[2:38] negative interest rate policy. Which has.
[2:41] Just ended. Involved applying.
[2:43] Different interest rates to different tiers of bank reserves
[2:47] in order to prevent the banks from hoarding.
[2:50] Cash achieving. The 2% inflation target.
[2:54] Is finally. Getting within reach.
[2:56] In Japan due to. Recent wage?
[2:58] Inflation, Japan's largest. Federation of Trade Unions.
[3:02] Recently. Negotiated A weighted average
[3:06] 3.7% increase in base. Pay.
[3:09] This was stronger than last. Year's.
[3:11] Wage gains, which were the steepest in 30 years.
[3:16] The Bank of Japan has said. That they expect higher incomes
[3:20] to lead to a virtuous spiral. With domestic demand fuelling
[3:24] inflation. They say.
[3:26] That their long held goal of. Stable 2.
[3:29] Percent inflation is finally within sight.
[3:33] There were no shock waves associated.
[3:35] With the announcement as the decision was widely expected and
[3:39] well telegraphed. Core core inflation.
[3:42] Which excludes fresh food and energy.
[3:45] Prices and is closely watched. By the Bank of Japan as a.
[3:49] Better gauge of. Trend inflation has been above.
[3:52] The 2% target for more than a year.
[3:55] But policymakers? Took it.
[3:57] Easy believing that some of this inflation was.
[4:00] Largely imported from overseas. The low.
[4:04] Return environment. In Japan has pushed.
[4:07] Japanese investors. Into being amongst the.
[4:10] Biggest capital exporters in the world?
[4:13] They own over a trillion dollars of U.S.
[4:16] Treasuries. And half.
[4:17] A trillion euro? Bonds.
[4:19] Now that. Domestic yields.
[4:21] In Japan might be on. The rise?
[4:24] Will they stop? Investing as much abroad.
[4:27] Japanese banks. And institutions have over the.
[4:31] Years become. Big foreign investors, decades
[4:35] of. Ultra low.
[4:35] Interest rates encouraged yield seeking Japanese investors to
[4:40] keep their savings overseas, particularly in.
[4:43] Foreign bonds. Commerzbank estimates that
[4:47] Japanese investors own more than $2 trillion in foreign bonds.
[4:52] And. International investments are
[4:54] estimated to be around $4 trillion in.
[4:57] Total low. Interest rates.
[5:00] Combined with the yen. Stability made it the currency
[5:03] of choice for carry trades where an investor borrows in yen to.
[5:07] Fund investments. In other countries where
[5:10] interest rates and expected returns are much higher.
[5:14] This style of investment can of. Course be quite risky.
[5:18] Big currency moves can wipe out returns and force investors to
[5:22] unwind their trades for this reason.
[5:25] The yen. Usually rallies during times of
[5:28] market stress as investors exit these trades and repatriate
[5:33] their money. To Japan, Japan is the.
[5:36] Largest foreign holder of U.S. government.
[5:38] Debt and. In a world of higher Japanese
[5:41] interest. Rates.
[5:42] Money that's been. Invested abroad could be
[5:45] brought. Back to Japan impacting the.
[5:47] Demand for US. Treasuries and.
[5:50] Euro denominated. Bonds.
[5:53] US bonds have. Already.
[5:54] Become less. Attractive to Japanese investors
[5:57] as? When they?
[5:58] Buy treasuries. They usually.
[6:00] Don't. Want to run the foreign exchange
[6:02] risk? And thus hedge it out.
[6:05] After hedging, U.S. Treasuries are the most
[6:08] expensive they've been in. Decades.
[6:10] For Japanese investors and for this reason.
[6:13] This trade has been. Unwinding over the last two
[6:16] years, John authors at Bloomberg points out that.
[6:20] Since the beginning. Of 20. 20.
[6:22] A carry trade of borrowing in yen.
[6:25] And investing in the. Mexican peso, where rates are
[6:28] above 11%, has made a far bigger profit.
[6:32] Than an investment in the S. And P500 Samurai bonds are.
[6:37] Yen denominated bonds. Issued by foreign entities.
[6:41] In Japan allowing non. Japanese governments and
[6:44] corporations to secure capital from Japanese investors, often
[6:50] at lower rates than they would get in their home markets in
[6:53] recent years. Highly indebted African
[6:56] countries like. Kenya, Egypt and Rwanda have
[6:59] issued samurai bonds. This debt has mostly.
[7:03] Been issued. At fixed.
[7:04] Interest rates, which means that the change in interest rate.
[7:08] Should not. Affect the.
[7:09] Borrowers, but if the. Yen were to appreciate against
[7:13] their currencies. It.
[7:14] Would be more expensive. To pay back these loans.
[7:18] For these reasons. Developments in Japan matter.
[7:22] For global markets. Japan's.
[7:24] Debt reached. 8.6. Trillion dollars at the end of
[7:28] last year at. 2. 155% of GDP. That's more than twice the debt
[7:35] to GDP ratio of the United. States and is the highest in
[7:39] the. Developed world.
[7:41] The future? Pace of rate increases.
[7:43] Will depend on a number of. Factors such as whether
[7:46] businesses and households can. Handle higher.
[7:49] Borrowing costs. Than they have become accustomed
[7:52] to servicing Japanese massive. Government debt is already a
[7:57] struggle. Which will.
[7:58] Become much more difficult when's negative interest rates
[8:02] and yield curve control? Have been abandoned.
[8:05] For Japanese. Banks.
[8:07] Higher interest rates can be expected to boost net interest
[8:10] margins. And the FT points out the
[8:13] Japanese banks. Have performed very well over
[8:16] the last year in. Expectation of.
[8:19] This interest rate. Hike which?
[8:21] Shares in Mitsubishi UFJ. Financial Group.
[8:24] Up more than 80% in the last year.
[8:28] Large. Japanese companies have 49% cash
[8:32] on their balance sheets as a proportion of net assets,
[8:36] according to the same article, and higher interest rates.
[8:39] Would help? These companies.
[8:41] Too should. Rates continue higher investors.
[8:45] In Japanese, bonds could face losses not unlike what we saw.
[8:50] When US rates rose rapidly last year, according to the Wall
[8:54] Street Journal. Japan's.
[8:55] Financial services. Agency.
[8:57] Warned regional. Banks in mid-july that.
[9:01] They should be ready to respond flexibly to rapid interest rate.
[9:05] Fluctuations. Very few Japanese bankers.
[9:08] Have any? Experience in a rising interest
[9:11] rate environment. Japan's share of.
[9:14] Global GDP in purchasing power parity terms fell from 9% in.
[9:20] 1990. To under 4%.
[9:22] Today and while deflation slowly made Japan.
[9:26] Relatively poorer, it actually worked out well for certain
[9:30] salaried workers who made a. Steady income.
[9:33] While prices fell around 1% per year.
[9:36] In the new inflationary environment, wages.
[9:40] Have been rising slower than retail prices, frustrating these
[9:44] Japanese workers. The past. 30 years have.
[9:48] Seen many. Fall storms.
[9:50] In Japan, the Economist points out.
[9:53] That while price inflation is still above 2%, it's already
[9:57] falling. They argue that for the trend to
[10:00] continue. Japan needs.
[10:02] Reforms that raise productivity. And boost.
[10:05] The potential growth rate. Otherwise, deflation could
[10:08] return. Japan is faced with some.
[10:11] Big structural problems. An aging population, Low growth.
[10:15] And high. Public debt while all developed.
[10:18] Countries are aging. None are doing so as fast as.
[10:22] Japan around the. Turn of the century the phrase.
[10:26] Japan's 2025 problem was. Coined, it referred to how.
[10:31] By 2025, all six and a half million of Japan's baby boom.
[10:35] Generation would. Be 70.
[10:37] Five or older. Japan in 2025 would become a.
[10:42] Super. Aged society the likes of which
[10:45] has not. Been seen before.
[10:47] Based. On current projections by. 2050.
[10:51] There. Will be.
[10:52] Almost the same number of workers in Japan as retirees.
[10:57] The elderly in Japan vote for and get old age benefits and
[11:02] many young. Japanese people.
[11:03] Don't vote. Aware that their numbers are
[11:06] not. Sufficient to.
[11:07] Counterweight. The votes.
[11:09] Of the elderly population in a country with.
[11:12] High debt. The high number of elderly
[11:15] people can be expected to put extreme strain.
[11:18] On the economy, welfare programs.
[11:21] And retirement. Plans, my friend Manoj at
[11:25] Talking Heads Macro. Argues that.
[11:28] The Bank of Japan's optimism that wage negotiations would.
[11:31] Deliver stronger. Nominal and.
[11:34] Real wage? Growth leading.
[11:36] To consumption. Growth might be wrong.
[11:39] He argues. That Japanese.
[11:40] Real wages? Have fallen.
[11:42] Over the last two years and that consumption growth will.
[11:45] Only come. After households have recouped
[11:49] the purchasing power they lost due to.
[11:51] Inflation, he says, that the households will need.
[11:55] Several quarters. Of wages.
[11:57] Outstripping prices before the wage level catches up with the
[12:01] price level. Only then will the.
[12:04] Japanese feel that their wages can be used for broad based
[12:08] consumption that. Time is not now.
[12:11] For the time being, a sharp increase in Japanese interest
[12:15] rates. Seems unlikely.
[12:17] Japanese policy makers have been careful to signal that.
[12:20] They are not. Embarking on.
[12:22] A tightening cycle and that the central.
[12:25] Bank is prepared to intervene to support financial stability if
[12:29] needed wages are still. Quite weak in Japan and.
[12:33] Further wage growth would be needed for inflation to remain
[12:37] on target. The Bank of Japan referred to.
[12:40] Extremely high uncertainty in their.
[12:43] Outlook meaning. That they just don't know if
[12:46] they're on track with inflation or not.
[12:49] A lot will depend on what happens if the.
[12:52] US Federal Reserve starts cutting rates as the difference
[12:55] between Japanese interest rates and US interest rates is.
[12:59] Quite. Wide at present.
[13:01] If the. Fed started cutting rates
[13:04] narrowing. That gap?
[13:05] The yen. Could start to rise as Japanese
[13:08] rates become relatively more attractive.
[13:11] This would make. Imports cheaper, putting
[13:13] downward pressure on prices. All of Japanese big.
[13:17] Structural challenges remain the same.
[13:20] And to quote. Robin Harding from the.
[13:22] FT It's not clear. If there's any stable
[13:25] equilibrium. Where Japan chugs along with.
[13:28] Consistently positive interest rates.
[13:31] And inflation at. Its 2% target.
[13:34] The Bank of Japan has. Signed an Armistice with
[13:37] unconventional monetary. Policy not.
[13:40] A peace treaty. Thanks for tuning into today's.
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