Angry banks complicate BOJ’s ability to deepen negative rates

By Leika Kihara

TOKYO (Reuters) – The Bank of Japan may have run into an unexpected obstacle as it considers expanding its extraordinary stimulus program as soon as next week — the wrath of the country’s powerful but typically compliant banks over pushing interest rates deeper into negative territory.

Bond traders were stunned this week when Bank of Tokyo-Mitsubishi UFJ (BTMU), one of the nation’s three megabanks, said it was giving up its status as a primary dealer of Japanese government bonds (JGBs), though the news did not immediately affect prices.

The move is seen as the clearest and most public display yet of growing distaste over the BOJ’s negative rate policy by one of the biggest players in the JGB market, shocking policymakers accustomed to seeing financial institutions happily finance Japan’s huge public debt.

Sources familiar with the BOJ’s thinking say BTMU’s decision may also complicate any eventual tapering of the BOJ’s massive JGB purchases, and may force the central bank to continue printing money for longer than it wants.

“It’s true the hurdle for deepening negative rates may have become higher than other steps like topping up asset purchases,” one of the sources said.

“Even expanding stimulus could be difficult,” another source said on condition of anonymity.

Some BOJ officials are concerned enough over signs of stress in the JGB market to speak up, including Deputy Governor Hiroshi Nakaso, who said on Thursday he was mindful of criticism that negative rates were causing “great damage” to market liquidity.

The episode comes ahead of a BOJ policy rate review next week. While most economists polled by Reuters expect the BOJ to keep policy unchanged, a majority believe it will ease again in July, either by cutting rates more deeply into negative territory or buying even more bonds and riskier assets, or a combination of both.

EXIT HURDLE RISES

Officials at BTMU, a core unit of Mitsubishi UFJ Financial Group <8306.T>, unofficially say they are quitting as a primary dealer because it does not make economic sense to meet the requirement to keep buying a certain amount of JGBs in each auction, when bonds are carrying negative yields. The benchmark 10-year yield hit a fresh record low of minus 0.155 percent on Friday.

There is no sign Japan’s two other megabanks will immediately follow suit. But some of the smaller banks and brokerages making up the 22-member primary dealer system may consider bailing out if the costs of holding JGBs becomes unbearable, analysts say.

BOJ officials sought to downplay BTMU’s move as an isolated event and informally stress that it won’t prevent the central bank from deepening negative rates if needed to reflate the economy.

Some say it is actually a sign the BOJ is succeeding in one of the goals of its stimulus, which is to drive domestic banks out of the safety of JGBs into riskier investments.

And BOJ Governor Haruhiko Kuroda has made clear that concerns held by financial institutions over negative rates won’t prevent the central bank from cutting rates further.

But some BOJ policymakers are more receptive to the voices of discontent and wary of cutting rates further. That is particularly so as the BOJ is still in damage control to mend relations with financial institutions strained by its abrupt decision in January to adopt negative rates, which caught many banks off guard, the sources say.

BTMU’s exit also highlights a more fundamental concern for the BOJ – the hurdle for ending its stimulus program.

The BOJ already holds a quarter of the 150 trillion yen ($1.4 trillion) JGB market and buys the equivalent of almost all new issues in the secondary market, while major Japanese banks have slashed holdings by half since the adoption of the BOJ’s stimulus program in 2013.

A diminished presence of domestic financial institutions, once stable buyers of JGBs, would make yields susceptible to spikes on any signs of a slowdown in the BOJ’s bond buying, analysts say.

“I think at some point the BOJ can start to think about tapering,” Sayuri Shirai, a recently retired BOJ board member who voted against adopting negative rates, said on June 1.

“Because the BOJ’s buying is so massive … just by tapering it could upset interest rates.”

(Additional reporting by Taiga Uranaka and Sumio Ito; Editing by Kim Coghill)