Historic Shift: Japan Ends Era of Negative Interest Rates

The Bank of Japan has ended the era of negative interest rates by raising borrowing costs for the first time since 2007, leaving behind decades of deflation.

Governor of the Bank of Japan Kazuo Ueda, with this historic move, which followed a two-day meeting of the Bank, has concluded a series of ‘ultra-loose’ monetary policies, abandoning a range of easing measures that were introduced to stimulate the most advanced Asian economy.

The central bank will now target an interest rate range of zero to 0.1 percent, becoming the last central bank to stop using negative rates as a monetary policy tool. Their benchmark rate before this decision was -0.1 percent.

The Bank of Japan turned to negative interest rates in 2016 to encourage banks to lend more to generate consumption and curb the risks of a slowing global economy.

The change in monetary policy in Japan is likely to eventually trigger changes in global investment flows, coming at a time of broader changes in the Japanese economy.

For instance, workers in some of Japan’s largest companies secured their biggest wage increase since 1991, giving the governor enough confidence that mild inflation will continue, which has been the Bank’s main goal for years, aiming for stable inflation of two percent and getting closer to that target.

Investors are also becoming more confident in the prospects of the Japanese economy, as the Nikkei 225 stock index reached record levels in early March.

However, with signals of further exchange rate growth, the Japanese yen weakened by 0.8 percent against the US dollar to 150.33 yen per dollar after the central bank’s move, while the yield on ten-year Japanese government bonds fell to 0.725 percent.

Inflation, driven by rising prices of imported energy and food, has passed its peak, and core inflation, which excludes volatile food prices, slowed in January for the third consecutive month.

– It is important to maintain favorable financial conditions even as we conduct normal monetary policy – said the governor of the Bank of Japan at a press conference.

Economists Divided

The central bank also stated that it will maintain its policy of monthly purchases of government bonds worth six trillion yen, or 40 billion dollars, highlighting the ongoing weakness of the economy while household consumption remains sluggish. However, they also announced that they would cease purchasing exchange-traded funds and Japanese real estate investment trusts.

As part of the new monetary framework, the Bank of Japan will apply an interest rate of 0.1 percent on deposits at the central bank, removing the complicated three-tiered borrowing cost system that was adopted to limit the impact of negative interest rate policies on commercial banks.

– Now that the major measures of monetary easing have fulfilled their role, we will need to consider reducing our balance sheet – said Ueda.

While the end of negative interest rates was largely expected, economists were divided on how far the Bank of Japan would go in abolishing other measures such as yield curve control and ETF purchases.

Sayuri Shirai, a former board member of the Bank of Japan who opposed the introduction of negative interest rates in 2016, stated that it seems the Bank has decided it has only one opportunity to act, as the economic conditions for further rate increases have not yet been established.

– We must give credit to Mr. Ueda for his determination and boldness. Instead of doing it gradually, he made a significant shift all at once – she said.

According to economists, the change in direction signals the beginning of the normalization of monetary policy, although it is likely to be slow at best, given the uncertain outlook for inflation. Additionally, markets have continued to react loosely as they do not believe that inflation in Japan will stabilize and that the central bank will be able to raise rates.

Nevertheless, many expect Japan to raise its benchmark rate to 0.25 percent in the fall and implement another increase in the spring of 2025 if economic conditions in the United States remain stable.