22 January 2020
The Bank of Japan did not expect the reaction of financial markets to the negative interest rate. Photo: Bloomberg
The Bank of Japan did not expect the reaction of financial markets to the negative interest rate. Photo: Bloomberg

Critical point for negative interest rate

At the end of January, the Japanese central bank joined the “negative interest rate club”.

The party in the financial markets lasted only for one day. Both the Japanese stock market and the yen started falling soon after a short rebound.

Such a reaction was completely out of the Bank of Japan’s expectation.

What did we learn from it? It shows us that the effectiveness of an unconventional monetary policy, in terms of boosting financial asset prices, has reached a critical point.

It may only bring a negative effect and instability instead.

Europe has a similar story. After the euro weakened and stock markets rose for several days, the euro exchange rate bounced back to 1.12 against the US dollar and Germany’s DAX index fell 224 points.

The focus now has switched from how the central banks’ policies would influence asset prices and the economy to how investors would interpret and react to those policies.

Central banks have been using various unconventional measures for over seven years while the market has constantly sought to make proper adjustments and establish better positions.

In this game, however, every step the central banks take and every change they make are traceable. The market will continuously make simulations of various scenarios to find the best action to take.

However, there’s one case that came out of the blue and shocked the market recently — the Swiss National Bank announced that it would no longer hold the Swiss franc at a fixed exchange rate with the euro.

As far as I can remember, this is the first time a central bank made a sudden move without warning the government in advance. The market would have learned the lesson from the panic.

I believe investors are now reacting to deal with the ineffectiveness of monetary measures.

The more extreme central banks’ policies become, the more investors rush to risk-aversion assets.

This article appeared in the Hong Kong Economic Journal on March 17.

Translation by Myssie You

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank