Yen strengthens despite shift to negative rates

The Bank of Japan’s decision to cut the interest rate on some excess reserves below zero initially delivered a slide in the exchange rate and a rise in equities. But these shifts soon reversed and the yen is now at its strongest level relative to the dollar since late 2014. Meanwhile, economic activity looks sluggish and lower energy prices threaten to undermine inflation expectations. In these circumstances, more easing will be required before long, and we suspect that short-term interest rates will fall much further than markets are anticipating. If we are right, the yen should weaken against the dollar once more while the Nikkei should rebound.