MNI POLICY: BOJ Mulls Framework Post Likely April Rate Liftoff

The Bank of Japan is on course to raise its benchmark overnight rate from negative levels as soon as its April 25-26 meeting, but officials remain uncertain as to what will then become the main interest rate target, MNI understands.

The Bank currently applies a negative 0.1% interest rate on banks’ excess reserves, but once this is moved into positive territory it will have the option of selecting either the unsecured overnight call loan rate or the interest rate on excess reserves as its new main policy rate, as detailed by Governor Kazuo Ueda to parliament last month.

If it opts for the former, it could allow the rate to move in a certain range, such as zero percent to 0.15%, and raise the interest rate on excess reserves from its current 0.1% to perhaps 0.2%, which would then act as a ceiling.

Under this scenario, whenever it adjusts its policy rate, it would first modify the interest rate on excess reserves and then conduct daily operations to move the call rate to within a range slightly below it.

On the other hand, if the BOJ sets the interest rate on excess reserves as its policy rate, the Bank will conduct daily open market operations to push up the unsecured overnight call loan rate, using sales of discount bills and of government bonds under repurchase agreements to absorb excess funds from markets.

MNI reported last year BOJ officials were looking at options to replace its three-tier system of interest on bank reserves as it geared for the end of its negative rates regime. (See MNI INTERVIEW: BOJ Eyes Tiering Options Ahead Of Rates Move) The deliberations come as the BOJ undertakes a broad review of its monetary policy.

The BOJ will likely end negative rates following wage hike data in mid-March, the BOJ April Tankan survey results, price revisions and the branch managers’ meeting. (See MNI POLICY: Solid Wage Data Needed Before BOJ April Exit Talk) Officials calculate that a policy shift at the preceding meeting in March, which comes immediately before the end of the fiscal year, could hit earnings at commercial banks and destabilise financial markets.

Changes to the policy framework will depend on how strongly the BOJ wants to control the short-term policy interest rate and how the bank sets the upper and lower limits of the policy rate. However, whichever framework the BOJ selects will have little effect on the way it conducts monetary policy, and interest-rate moves are likely to come in cautious increments.

OVERSEAS EXAMPLES

BOJ officials are also carefully considering the policy frameworks employed by the Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank.

It is possible that the BOJ will adopt a framework like the previous ECB method, which used the marginal lending rate as a ceiling with the deposit rate as a floor. The ECB currently targets the deposit rate alone due to the scale of excess liquidity in the financial system, but is currently studying future options.

The Fed, meanwhile, uses the interest on reserve balances (IORB) as the federal funds rate's ceiling.