Bank Of Japan’s NIRP Contracts Rather Than Expands: CS

Bank Of Japan’s NIRP Contracts Rather Than Expands: CS

The Bank of Japan is one of the newest central banks to adopt a negative interest rate policy (NIRP), and we’re already starting to see some of the negative impacts investors were worried about. Typically, the point of monetary easing is to expand the economy, but analysts are seeing the opposite happen in Japan following the adoption of the NIRP.

Skeptical about the Bank of Japan’s move

Analysts from Credit Suisse and CLSA both issued reports this week highlighting the problems that are already coming out of the Bank of Japan’s new negative interest rate policy.

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Credit Suisse analysts Hiromichi Shirakawa and Takashi Shiono said they’re skeptical of the move and believe that the central bank’s NIRP is contracting rather than expanding the Asian nation’s economy. One of the big reasons they’re skeptical is because bank stocks in Japan have effectively collapsed since the Bank of Japan announced the negative interest rate policy.

They draw a clear line in the sand between negative interest rates and quantitative easing (QE), with the former only now becoming a frightening trend and the latter having already been tested in some countries, including the U.S. QE targets expanding the outstanding monetary basis, but even it isn’t without problems, they say.

The Credit Suisse team adds that the big variable here is the yield curve’s shape. They said the profitability of private banks usually deteriorates (as we have seen now with NIRPs in Japan and Europe) if the curve flattens. Further, banks’ capacity for “financial intermediation” erodes, which eventually results in weaker loan growth. As a result, they said any monetary easing action that flattens the yield curve is actually “contractionary” rather than “expansionary,” and they believe the Bank of Japan’s negative interest rate policy will be contractionary.

Three possible outcome from the Bank of Japan’s NIRP

One is: “Bond-buying operations reach an impasse, monetary base targeting is abandoned.” The Credit Suisse team suggests that the market could refuse to sell Japanese government bonds in “necessary quantities” under the Bank of Japan’s asset purchase program. Under this program, the BoJ must expand the nation’s monetary base while also imposing negative interest rates on bank balances. The reason this could happen is because private banks might refuse to participate in the program “in the hope of alleviating downward pressure on market rates,” thus forcing the central bank to abandon the policy.

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The second is: “Private-sector bank deposit growth slows, monetary base targeting is abandoned.” If private banks do keep selling JGBs to the Bank of Japan while also virtually lowering their retail deposit rates by adding fees. The point of this exercise would be to “offset downward pressures on their net interest margins from loan rate declines,” said the Credit Suisse team. While the monetary base could keep growing, growth could slow “or at least become less stable, with the BoJ current account balances no longer accumulating steadily at the current pace, thereby rendering the BoJ’s monetary base targeting approach unviable,” they wrote.

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And the third is: “Private-sector banks reduces [sic] lending.” This could happen because private banks might worry that their capital positions will deteriorate, so they could cut lending, particularly if there is political pressure to participate in the Bank of Japan’s government bond buying program.

How to invest in Japan amid the negative interest rate policy

CLSA analyst Nicholas Smith suggests some strategies for investors who want to invest in Japan but are unsure how to play the Bank of Japan’s NIRP. One option he said is to buy the yen, which he said is “overrated as a profit driver,” a view many investors currently have. The price to earnings ratio is currently moving in line with the currency, which he says offers “an attractive entry point” as it sits at 12.1 times consensus FY3/17 earnings.

He also sees the NIRP as a positive for construction, real estate investment trusts, and real estate but bad for financials because it pressures banks to lend. However, he also thinks Japanese bank stocks have overreacted to this risk.

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