Will Japanese NIRP Boost Gold?

The Bank of Japan adopted negative interest rates last Friday. What does it mean for the U.S. economy and the gold market?

Rate Cut

The Japanese insane monetary policy became even more insane. The Bank of Japan announced that it “will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank. It will cut the interest rate further into negative territory if judged as necessary”. Importantly, the Bank of Japan will adopt a three-tier system in which the outstanding balance of each financial institution's current account at the Bank of Japan will be divided into three tiers, to each of which a different interest rate will be applied. As one can see in the graph below, the three-tier system will be divided into a basic balance, macro add-on balance and policy-rate balance.

Graph 1: The three-tier system adopted by the Bank of Japan

Source: Bank of Japan

The rate on existing reserves (i.e. reserves accumulated at the BOJ before the NIRP’s introduction) held at basic balance will remain at 0.1 percent. The rate on the amount outstanding of the required reserves and of the Bank's provision of credit through the Loan Support Program and the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the Great East Japan Earthquake will be at zero percent. The negative interest rate of minus 0.1 percent will be applied to the outstanding balance of each financial institution's current account at the Bank of Japan in excess of the amounts outstanding for the basic balance and macro add-on balance. In other words, commercial banks will have to pay the central bank for new reserves (not already existing ones) held at the Bank of Japan that exceed those required by regulators. Therefore, the impact of the negative interest rate will be limited and it will materialize only over time as the BoJ keeps buying assets and creating new bank reserves.

What Does the Japanese NIRP Mean for the U.S. Economy and the Gold Market?

The introduction of the negative interest rates by the Bank of Japan is the best proof that quantitative easing did not work. The adoption of NIRP is an act of desperation to achieve the 2-percent inflation rate. Instead of admitting that ultra-low interest rates and money printing conducted for decades failed to bring the desired results, the Bank of Japan simply lowered the interest rates below the zero. However, this will not help the economy, which needs restructuring and structural reforms. Instead, it will support the stock market and weaken the yen, as the financial institutions will buy foreign and financial assets instead of keeping money at Bank of Japan. Thus, the Japanese NIRP implies a stronger U.S. dollar (indeed, the greenback appreciated almost 2 percent against the yen since Friday).

On the one hand, the appreciation of the U.S. dollar will exert downward pressure on the price of gold. On the other hand, it will further dampen inflation by lowering the cost of imports. Thus, the Japanese NIRP lowers the Fed’s ability to further hike interest rates. The Fed funds future contracts suggest that markets expect only one hike in 2016, not earlier than in December.

Conclusions

The key takeaway is that the Bank of Japan introduced negative interest rates. The impact on the gold market is ambiguous. On the one hand, this pushes up the U.S. dollar, which is negative for the price of gold. On the other, it lowers the Fed’s ability to further tighten its monetary policy. It is also an act of desperation of the Bank of Japan, and should result in some safe-haven demand for the bullion. It seems that bullish effects outweigh the bearish ones since the price of gold has increased since Friday. However, investors should remember that the impact of negative interest rates in Japan will be limited, due to their already low levels and the three-tier system adopted by the Bank of Japan.

Arkadiusz Sieron