After a decade of ultra-loose monetary policy and 8 years of sub-zero borrowing costs, Bank of Japan Governor Kazuo Ueda made the decision to direct the interest rate to a range between zero and 0.1% (Associated Press)

Central banks around the world took important steps in a week of pivotal shifts in monetary policy that set new trends for the global economy. The Swiss National Bank, buoyed by progress in managing inflation, began a historic cut in interest rates, breaking away from its global peers.

Meanwhile, Norway signaled a pause in interest rate adjustments for the foreseeable future. However, the most significant move came from Japan as the Bank of Japan ended its unprecedented negative interest rate policy, marking the end of an era in modern monetary history.

The negative interest rate regime adopted by the Bank of Japan was a radical strategy aimed at stimulating bank lending, boosting demand, and addressing the problem of inflation. Ending this policy signals a move away from unconventional monetary instruments that have characterized Japan's economic landscape for many years. The move has sparked discussions about the future course of Japanese monetary policy and its potential implications for the global economy.

Borrowing below zero

After a decade of ultra-loose monetary policy and 8 years of sub-zero borrowing costs, Bank of Japan Governor Kazuo Ueda made the decision to direct the interest rate to a range between 0 and 0.1%. The move, Japan's first increase in borrowing costs in 17 years, comes at a unique juncture as other major central banks consider cutting interest rates, which could significantly change the yen's role in financial markets, according to investors and economists.

The Bank of Japan also announced the abandonment of the yield curve control policy introduced in 2016 to maintain the yield on 10-year Japanese government bonds (Reuters)

According to Bloomberg, this move reverses the previous policy of imposing a 0.1% fee on some excess reserves held by financial institutions at the central bank. Analysts view this shift as an important step towards normalization, indicating confidence in the path of the Japanese economy.

“Today the Bank of Japan ended an era of extraordinary monetary easing,” Morgan Stanley analysts said in a research note. They described the move as an indicator of a virtuous cycle of rising growth in nominal GDP, wages, prices and corporate profits.

As part of its exit from the negative interest rate policy, the Bank of Japan also announced the abandonment of its yield curve control policy, which was introduced in 2016 to maintain the yield on 10-year Japanese government bonds to maintain accommodative financial conditions. In addition, the bank will stop buying Japanese exchange-traded funds and real estate investment trusts.

Markets are affected

The benchmark Nikkei 225 index in Japan witnessed fluctuations during trading following the decision, as it initially reversed slight losses and rose after news of the interest rate hike, before slipping into negative territory again. It eventually closed up 0.7%. The broader Topix index closed 1.1% higher.

While the Bank of Japan's decision represents a shift towards normalization, the bank reaffirmed its commitment to maintaining easy financial conditions "for the time being." This suggests that the Japanese central bank will not embark on an aggressive tightening cycle similar to other major central banks, such as the US Federal Reserve.

Looking ahead, uncertainty remains, with risks including developments in external economies, commodity prices, and the wage-setting behavior of domestic firms. Analysts from Capital Economics expressed to CNN their doubts about further increases in interest rates, citing expectations of weak wage growth among small businesses.

How will the yen be affected?

For more than 3 decades, the Japanese currency has maintained a stable position in foreign exchange markets, largely due to the Bank of Japan's policy of low or negative interest rates aimed at stimulating economic growth and preventing deflation.

This stability has made the yen an attractive option for investors involved in carry trades, a strategy where investors borrow in a low-yielding currency to invest in high-yielding assets. In addition, the yen has been the preferred financing route for governments and corporations during times of crisis, with many choosing to issue "samurai bonds" in yen in the Japanese market.

Despite the initial decline in the value of the dollar following the Bank of Japan's announcement, analysts believe that the yen is still attractive due to the large interest rate differential with the United States (Reuters)

Despite the initial decline in the value of the dollar following the Bank of Japan's announcement, analysts spoken to by the Financial Times believe the yen remains attractive due to the large interest rate differential with the United States. However, Shusuke Yamada, head of Japan FX strategy at Bank of America, notes that shifts in the appetite of domestic Japanese institutions for carry trades abroad may occur if Japanese government debt becomes more attractive.

Derek Halfpenny, head of research at Mitsubishi UFJ Financial Group, told the Financial Times that this shift in the Bank of Japan's policy represents a historic turning point, which could lead to increased volatility in the yen. The newfound volatility coupled with expectations of further interest rate hikes may reduce the yen's appeal to investors.

Who will the yen affect?

The Bank of Japan's decision also resonates in international markets, particularly affecting governments that issued yen-denominated bonds. While existing borrowers may not be immediately affected, the potential rise in the yen's value could lead to escalating debt repayment costs for some developing countries, Elvira Mami, chief economic analyst at the Overseas Development Institute, told the newspaper.

Mark Farrington, global macroeconomic advisor at Farrington Consulting, noted that the yen now holds upside potential following the Bank of Japan's decision, indicating a potential long-term rise in line with other economic changes in Japan.

However, these changes could also affect investors, companies and governments, as they can no longer rely on the stability of the yen in carry trades or seek refuge in times of economic turmoil.

The changes could also affect investors, companies and governments, as they can no longer rely on the stability of the yen in buying deals, according to observers (Reuters)

Jonathan Peterson, chief market economist at Bloomberg Capital Economics, stressed the importance of the Fed's policies in determining the short-term direction of the yen against the dollar, suggesting that the Bank of Japan's decision may have less impact in a world where the Fed has significantly raised interest rates.

Yamada highlighted that while Japanese companies may continue to take advantage of cheap yen financing to expand overseas, changes in the attractiveness of Japanese government debt could affect domestic institutions' appetite for external leverage.

As the financial landscape adapts to these changes, stakeholders will closely monitor the evolving dynamics in the yen's role in global financial markets, and assess the implications for investment strategies and borrowing costs.

Source: Al Jazeera + agencies