In a surprising move after a two-day monetary review meeting that ended Friday, the Bank of Japan adopted a negative interest rate policy in an attempt to revive the country’s economy. Japan is currently struggling with low inflation rates and weakness in the global economy, which threatens the fiscal reforms of Prime Minister Shinzo Abe directed towards combating deflation in the world’s third largest economy. (See also: Japan's Strategy To Fix Its Deflation Problem.)

The Bank of Japan stated a cut in deposit rates that the central bank pays to commercial banks. The move is intended to move excess reserves from 0.1% to negative 0.1%. The primary objective is to encourage borrowing and drive up inflation. They said in a statement, the objective of negative interest rates is to “pre-empt the manifestation of [downside] risk and to maintain momentum to achieve the price stability target of 2%.” It also said, “We will cut the interest rate further into negative territory if judged as necessary.”

The Bank of Japan also announced it will keep its asset repurchasing program at the existing level of Y80 trillion annually.

Will Japan Reach Its 2% Inflation Target?

The central bank's move to adopt a negative interest rate policy indicates it is becoming desperate to achieve their target inflation of 2%. This has been the primary agenda for Prime Minister Shinzo Abe since the beginning of his term.

When Japan announced its quantitative easing program in 2013, the timeframe to achieve 2% inflation was 2015, but it was extended to late 2016 or early 2017 in October 2015. With the move announced on Friday, the timeframe to achieve this target has been pushed further back in 2017. The Bank of Japan believes that their economy “has continued to recover moderately.” However, the global stock market rout and persistent decline in oil prices have pared down their hope to achieve their inflation target.

Japanese Stock Market and Yen Gain

Investors were upbeat with the announcement. The Nikkei 225 is trading in the positive territory. At the same time, the yen depreciated by around 1.65% against the dollar to reach 120.75. A weaker yen is positive news for the export driven Japanese economy.

The worst performing sector after the announcement was the banking sector. Shares of Mitsubishi UFJ Financial Group lost 2.81% of its value, while Sumitomo Mitsui Financial Group was down by around 1.7%.

The Bottom Line

Japanese investors, however, had to face a highly volatile session on Friday, as stock markets first gained, then gave away gains as investors contemplated the implications of the move to the banking system. Takuya Takahashi, a strategist at Daiwa Securities, said, “Investors have had a hard time assessing what the BOJ's announcement means to the Japanese economy. After all, the market cheered the BOJ's decision as a weak yen is positive for Japan Inc.”