5 things to know about negative interest rate policy

In a surprise move, the Bank of Japan (BOJ) cut its benchmark interest rate below zero for the first time. The benchmark rate now stands at -0.1 per cent. Business Standard explains what this means.

What does negative interest rate mean?

With the benchmark rate now at -0.1 per cent, it essentially means that the BoJ will charge commercial banks 0.1 per cent on some of their deposits.

According to a report in The Financial Times, negative interest rates will be adopted on the basis of a three-tier system. The current account that each financial institution maintains at the BOJ will be divided into three tiers, on which a positive, zero and negative interest rate will be applied.

Which other central banks have pursued a similar policy?

In June 2014, the European Central Bank became the first major central bank to adopt negative interest rates. It charged banks 0.3 per cent for holding their cash overnight. Sweden, Denmark and Switzerland also have deposit rates below zero.

Why has BoJ adopted such an unconventional monetary stance?

BoJ seems to be worried about a slide into deflation territory. Consumer prices have remained stubbornly low, suggesting that demand continues to remain muted with consumers postponing purchases. This could derail the recovery.

According to analysts, collapsing inflation expectations is the key reason for the unexpected move. While the BOJ governor is previously reported to have said that it would hit the two per cent mark by 2016, BoJ now forecasts core inflation to average 0.2 to 1.2 per cent between April 2016 and March 2017.

What will be the impact of this unconventional policy move?

By charging banks for holding their money, BoJ is hoping that it will spur banks to lend. Theoretically, if bank lending expands, it could boost consumption and investment, and push growth.

Lower rates could also help push down the Yen which could help boost Japanese exports. It might also trigger another round of competitive devaluations as countries try to increase their share in global trade.

How have banks behaved while in a negative interest rate scenario?

Many fear that in practice if banks make their customers pay to hold their money, it might lead to a situation where consumers hold on to cash.
It is equally possible that banks may not pass on the charge to their customers.

According to economists at the Deutsche Bank, banks in Europe have not passed these costs onto customers and have preferred to lower their profit margin between lending and deposit rates.