Analysis: Bank of Japan’s interest rate surprise

We are used to Central Banks signalling what they are up to well in advance. Not the Bank of Japan. Its decision to reduce one of its key interest rates to below zero - effectively charging banks in some instances to lodge deposits with it – took the markets completely by surprise. It is yet another policy move by a major central bank to try to tackle the extraordinary low rates of inflation and growth, and in the case of Japan is a response to what has been happening in China, and the falling value of the renminbi.

The response in markets was immediate. Shares and oil, which tend to move in tandem these day, are on the rise again this morning. The smell of more central bank stimulus has also given a boost to government bonds and shorter dated European government bonds for many countries, including our own, are being pushed firmly into negative territory.

Volatility ahead

Equity markets have taken on a better tone this week after the big drops early in the year and the recovery in oil prices has helped. More volatility undoubtedly lies ahead, given the host of unpredictable factors driving markets and particularly the fears about China and emerging markets.

The next benchmark came from the world’s biggest economy. US GDP figures due at lunchtime showed a slowing in annualised growth from 2 per cent in the third quarter to 0.7 per cent in the fourth, a bit below expectations. The underlying fall in growth may not be as dramatic, but added to recent results from big US companies there are clear signs of slowing growth. The markets chose to focus initially on the prospect that this would slow the pace of US interest rate increases, but fears about US growth could still drive shares in the opposite direction.

Race to the bottom

The Japanese move highlights one other issue - the risk of a race to the bottom. The ECB has already cut its deposit rate to below zero and its benchmark rate to nearly zero. The Swiss and Swedish central banks have also moved to negative rates. Despite the recent rise, US base rates are at a paltry 0.25 per cent and now future increases may be slower than anticipated. Part of this is to try to get currencies lower to boost economic activity and inflation. The yen fell after today’s move. But if everyone is doing the same thing at the same time, it isn’t going to work.