James Smith, Economist at ING, suggests that the Bank of Japan caught markets off guard and introduced negative interest rates, although the overriding message was that this is likely to be just the first of potentially many rate cuts to come. Key Quotes “Perhaps the biggest lesson of all of this is that the BoJ is more sensitive to JPY strength than had been earlier thought. Heading into the meeting, the yen was stronger on a trade-weighted basis than it was before the October 2014 meeting. Going forward, currency movements are likely to be a key gauge of whether we can expect further cuts. In March, this is likely to heavily depend on what the ECB delivers and, given that further stimulus is widely expected, there is a high chance the BoJ will follow with a 10bp cut. The case for near-term action is likely to be boosted by a further drop in consumer inflation expectations (an important factor in the BoJ’s reaction function), which are driven primarily by expected changes in food prices rather than oil. With the effect of a significant yen depreciation in 2014 filtering out of the numbers, food inflation is set to fall fairly noticeably over the next few months and, in turn, weigh on expectations. While the probability of a near-term cut seems fairly high, we do not think that this will evolve into an aggressive easing cycle. The limitations of QQE are now well documented and we feel that an acknowledgment of this was implicit in January’s decision (after all, QQE would have been the go-to tool if it was seen as a viable option). Thus, rate cuts are now the major weapon in the BoJ’s arsenal and they will be wary of running out of ammunition too quickly. In the longer term, the BoJ is likely to have to consider scaling back the pace of JGB purchases. While it is hard to pin down when this process will commence, it could come as early as autumn (post-election) or, failing that, after the April 2017 consumption tax hike. Either way, when the decision is taken, it is likely to be coupled with further rate cuts to dampen any adverse market impact.” For more information, read our latest forex news.