When Japan adopted a zero interest policy two decades ago, it seemed an anomaly, but now that the symptoms of low inflation, low growth and low interest rates are spreading around the world, investors are asking whether Japanisation is here to stay
Just over two decades ago, Japan gave economists and investment managers a strange new acronym — ZIRP or zero interest rate policy. While sounding like an alien from the Space Invaders game, it marked the start of a new era of low growth, inflation and interest rates affecting many western economies, and it’s come to be known as Japanisation.
In October 1999, the Bank of Japan (BoJ) cut its official interest rate to zero. Two years later, it started to use quantitative easing (QE) policies, increasing how much commercial banks had to hold in their accounts at the BoJ far in excess of the reserve levels previously required.
What at the time were regarded as highly unusual measures were a response to a series of events that initially reassured global investors that this was purely an issue for Japan.
But since then, major economies across North America and Europe have found themselves languishing in an environment of low inflation and low growth that has forced them to slash interest rates and inject money into the financial system.
“Look closely, and to a greater or lesser extent, much of the developed world seems to be turning at least a little Japanese,” says Neil Shearing, Group Chief Economist at consultancy Capital Economics.
It’s worth examining Japan’s track record. The reasons for, and some of the causes of, its problems will be familiar to today’s investors, while others are due to the nation’s own circumstances.
In 1985, Japan and the other six of the Group of Seven (G7) nations agreed to a significant appreciation of the yen, bringing exports to a standstill and abruptly halting growth. The BoJ slashed interest rates to a then-low of 2.5% and adopted QE, while the government launched a fiscal stimulus.
The cheap borrowing costs fuelled a boom in the equity and housing markets that the BoJ tried to curb with sharp hikes in interest rates. The resulting crash in 1990 left the banking sector holding a pile of non-performing loans.
Eurozone as epicentre
Fast forward almost 20 years and many economies in the West have fallen victim to similar symptoms following the global financial crisis of 2008 and 2009.
Central banks and governments have struggled to stimulate economic growth and inflation in the wake of a severe banking crisis, despite cuts in interest rates to zero and the injection of trillions of dollars into the financial system.
Major advanced economies, including the UK, US and Australia have seen inflation rates fall and growth stagnate, although they have not fallen into negative interest rate territory. In fact, the US Federal Reserve raised rates nine times from late 2015 to mid-2019 before it started cutting again.
But the epicentre of Japanisation is the eurozone, where the European Central Bank has held its main refinancing rate at zero since 2016. In September last year, it cut the deposit rate by 10 basis points (0.1 percentage points) to -0.5% and unveiled an open-ended QE programme of €20bn a month.
Despite this, its inflation rate has hovered around 1% to 1.5% for the past five years, almost consistently beneath its target of 2%.
Carsten Brzeski, Chief Economist for investment bank ING in Germany, says the eurozone is now showing pronounced similarities with Japan in the early 1990s. “A financial crisis turns into an economic crisis, which then turns into a banking crisis and finally into an existential crisis,” he says.
Investors must cope
As a result, all actors in the eurozone economy have had to get used to the new environment of low inflation and low or negative interest rates.
For Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, banks are the primary victims as low inflation or deflation, and near-zero or negative interest rates, hamper their growth potential and profitability.
“Banks find it very difficult coping with low growth,” he says. “If you have started to go in a direction where people expect prices to fall and are worried about their job prospects, that is bad news.”
Amit Kara, Associate Research Director for Global Macroeconomic Analysis at the National Institute of Economic and Social Research (NIESR) in London, says asset managers will come under sustained pressure to deliver the rates of return their clients want in an environment of low interest rates.
They respond by looking for higher yields, seeking out assets that will deliver higher returns such as property and even alternative assets such as art, all of which tend to be more illiquid.
“That may mean taking on currency risk and exposing themselves to sectors and regions they may not have otherwise been prepared to do,” Kara says.
Low interest rates and borrowing costs have favoured assets such as property and equities in some stock markets, but the downside of this is a negative impact on those who do not own assets, such as young people and those on low incomes.
This has been compounded by the meagre growth in wage levels. For instance, in the UK, average hourly wages are roughly at the same level now as they were in 2008, according to the Institute for Fiscal Studies. Given that they usually rise every year, this means they are 19% below the level they would have been had long-term trends continued.
“Consumers are becoming aware that this may be a low-inflation world, which they like, but it is also a world of low real incomes growth – and people can get upset by that,” Milligan says.
Here to stay
The question facing policymakers, financial firms and households alike, especially in Europe, is whether their Japanised economy is here to stay.
Perhaps the downsides have been overplayed. Shearing at Capital Economics says that since the start of this decade, Japan’s working age population has contracted by about 0.5% a year. Yet despite this, GDP has risen by an average of 1.3% a year, while GDP per capita has increased by an average of 1.5% a year.
“Japan’s economic performance has not been all that bad – or at least not so bad as to justify some of the more extreme headlines it’s received,” he says.
One concern for the eurozone is that negative interest rates have left policymakers with fewer tools to combat another downturn. Economies such as the UK and the US managed to avoid negative interest rate territory by intervening effectively to sort out their crisis-hit banks – something the eurozone has been slower and less effective at doing.
Kara believes that Japan’s experiences show that it will be very hard to escape a low-growth and low-inflation environment without reverting to looser fiscal policies and policies aimed at increasing productivity growth.
Holger Schmieding, Chief Economist at German bank Berenberg, says that Japanisation is probably here to stay, but that it is wrong to see the eurozone as “suffering” from it. “Low interest rates and very low inflation are not that bad,” he says. “There are no features of deflation or any evidence of the real burden of debt stifling anybody.”
There is not much that policymakers could or should do about it, he says. “It is a global phenomenon – global interest rates are low and will remain low. It is for demographic reasons that the eurozone is even lower than the US, where they are running deficits of 4% or 5% of GDP.
“If you have reckless borrowing here, you could get interest rates up, but I am not sure that is the right recommendation.”