Unfortunately for the soundness of the sleep among BOJ-watchers, Mr. Kuroda believes that surprising the market is the best way to achieve his intended result. He learned this from his days as the head of forex intervention at MOF more than a decade ago, and all of the major developments during his BOJ leadership have been enormous surprises. Of course, European central banks have had even more onerously negative rates for quite a while, so the BOJ's decision is not radical and should have been somewhat expected, but it wasn't, so markets strongly reacted.

The BOJ's true intent is to not to start a currency war, but to incentivize domestic business investment and risk taking in Japan, not only by banks, but also by companies and individuals. For banks, they must now choose among two risks: one is to lose money "conservatively" for their newly accumulated assets, and the other risk is via lending them out. Clearly, the latter can have positive outcomes, if implemented correctly, not just for the bank, but also for the broader economy. It is also possible for banks to invest in even more overseas acquisitions, but this is counter to the goal of the BOJ. The BOJ's risk-incentivizing policy goal has existed for many years, even before Mr. Kuroda's tenure, including, among others, via buying equity ETFs in order to boost retail investor sentiment, and while it is impossible to state definitely that it has worked well (although equities, urban land prices and bank lending volumes have all improved and the economy is at full employment and growing near its "potential rate"), it is likely that conditions are better than if it had not taken any actions. We believe that this will be true this time as well, although certainly the financial sector now has their "feet to the fire," as do many investors.

As for financial markets, the negative policy interest rate will only apply to a small portion of bank total reserves (though growing with time), but bond yields reacted very strongly anyway, falling into negative territory well into the "belly" of the yield curve for the first time, which means that investors (including the BOJ) will be harmed by putting new assets (or former ones being rolling over) in conservative investment vehicles. Actually, policy rates and bond yields have been negative in real terms for over two years, but this new policy sharply reinforces this trend. So, investors need to find other investments or suffer the consequences. Retail bank depositors will likely continue to get 0% (as in other negative policy rate countries), but the BOJ is making sure that most large corporations and banks will not. What will they buy or will they simply accept the loss rather than take risk? It is impossible to know for sure, but it is very likely that they will take on more risk than would have otherwise.

Another reason for negative rates is that QE seems unable to contribute much further to the BOJ’s goal and the size of the BOJ's balance sheet is already large. Indeed, negative policy rates likely can anchor bond yields low enough that QE could even be tapered, especially if the BOJ makes fewer reserves subject to the 0.1% rate (that is on most existing reserves) or decreases the negative interest rate even further for "excessive" reserves.

One last reason for the BOJ's surprising action is that it is likely being pro-active rather than waiting for worse economic conditions to develop, as the global economy has surprised to the downside recently. Indeed, this move opens the possibility of decreasing the rate further, which is a new, powerful weapon, like in the ECB's current arsenal, to counter a further worsening economy.

Of course, the Yen weakened on this news, but once again this was not the main goal. It helps achieve that goal, as does the associated rise in equity prices, but a much weaker Yen is not likely desired by the BOJ, especially when voters are tired of too much food inflation and when the Japanese government is hoping that the US Congress will pass TPP legislation. One may notice that this piece has not mentioned the CPI, which the main symbolic target for the BOJ's success. Yen weakness will help achieve a higher CPI, but this will be only temporary help unless a broader economic and asset-price recovery lifts housing rents and fully counters deflationary sentiment. Japan still has some way to go in this regard, especially given the recent global backdrop, and until then, the soundness of the sleep of BOJ-watchers (and other asset class strategists) will likely be light indeed.