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The Bank of Japan said it would begin to “significantly” scale back its ¥6tn ($38bn) monthly bond-buying programme, a critical milestone in unwinding its ultra-loose monetary policy and tapering its expanded balance sheet.
The yen weakened almost 0.8 per cent to ¥158.26 against the dollar on Friday, the lowest level since multiple government interventions from late April to May, after the Japanese central bank put off specifics for its cuts to purchases until next month.
“It is appropriate to reduce the bond purchases in a predictable manner while also ensuring flexibility for market stability. If we are to start reducing [the purchases], we believe the size will be significant,” BoJ governor Kazuo Ueda said at a news conference, adding that the specific amount and pace of reduction would be outlined after hearing the views of market participants.
Ueda has faced pressure from the declining yen, as weak domestic consumption has made it difficult for the central bank to narrow the gap between Japan’s borrowing costs and higher interest rates in the US.
The US Federal Reserve this week signalled plans to make just one cut this year to interest rates that are at 23-year highs, maintaining its hawkish stance.
In a statement, the BoJ said its decision to reduce purchases of Japanese government bonds over the next one to two years — which was opposed by one board member — was intended “to ensure that long-term interest rates would be formed more freely in financial markets”.
The BoJ also said it would maintain its overnight interest rate within a range of about zero to 0.1 per cent, a widely expected move. The bank in March ended its era of negative interest rates, raising borrowing costs for the first time since 2007.
Even as it begins to trim its JGB purchases, the BoJ is unlikely to make any bold shift towards quantitative tightening, such as suspending asset purchases or even selling assets. Instead, officials think they can take advantage of an uneven maturity schedule to wind down the portfolio gradually even as they keep buying new bonds.
The annual amounts maturing from the portfolio will run at about ¥70tn during the next few years. With the BoJ buying bonds at barely that pace, small adjustments to the purchase schedule could tip the portfolio into decline.
Goldman Sachs expects the BoJ to gradually reduce the amount of its monthly JBG purchases from ¥6tn to ¥5tn. Under its ultra-loose monetary easing programme, the BoJ’s holding of JGBs has increased to ¥593tn at the end of May, from ¥91tn at the end of March 2013.
In May, the BoJ surprised markets by buying a smaller than expected amount of five- to 10-year JGBs during its regular operation. Since then, long-term yields have risen to their highest level since July 2011, hitting 1.1 per cent. That had prompted some investors to anticipate that the BoJ would announce how much it would start trimming its bond purchases this week.
“The recent decline in the yen is a factor for pushing up prices, so we are watching closely its impact in guiding our policy,” Ueda said.
Izuru Kato, a longtime BoJ watcher and chief economist at Totan Research, said the BoJ faced more challenges than its US and European counterparts in specifying the pace of its tapering. Japan’s debt, at about 2.5 times the size of its economy, is vulnerable to any uptick in yields caused by a rapid reduction in the BoJ’s bond purchases.
“The BoJ ended its policy of negative interest rates and yield curve controls, but markets are assuming that it will not be able to raise rates quickly and it needs to be cautious about quantitative tightening due to the massive issuance of JGBs,” said Kato, adding that changing market expectations would require a much more aggressive plan to cut JGB purchases.
Investors now expect the BoJ to carry out a small rate rise in July, although the weaker yen’s impact on consumption has made it harder for the central bank to confirm a virtuous cycle between rising wages and prices.
On Friday, Ueda did not rule out a rate rise at the same time as when the bank offers details on its bond tapering plan in July, but he cautioned that its decision would be guided by the economic data available.
“If the BoJ persistently maintains accommodative conditions, the yen will weaken further and real wages will not turn positive,” Kato said. “The BoJ is stuck in a difficult loop.”
Additional reporting by Leo Lewis in Tokyo and William Sandlund in Hong Kong
