BOJ to Discuss Cutting Bond Purchases Amid Rising Yields and Yen Pressure

Key Takeaway

• The Bank of Japan is expected to discuss reducing its ¥6 trillion ($38.6 billion) monthly bond purchases, signaling a shift towards quantitative tightening.
• Governor Kazuo Ueda faces pressure to balance bond buying cuts without causing sharp yen depreciation or rising bond yields.
• Japanese bond yields have reached decade-highs, and the BOJ's potential reduction in JGB purchases aligns with its long-term goal of shrinking its balance sheet.

BOJ Considers Cutting Bond Purchases

The Bank of Japan (BOJ) is expected to discuss reducing its bond purchases at a policy meeting ending Friday, with some investors anticipating that the central bank may also set the stage for raising interest rates next month. Governor Kazuo Ueda and his fellow board members are predicted to maintain the policy rate in a range between 0 and 0.1%, according to a Bloomberg survey of economists. A majority of the surveyed economists predict the board will opt to cut bond purchases from around ¥6 trillion ($38.6 billion) per month.

Sources familiar with the matter indicated that the BOJ will likely consider whether the timing is appropriate to reduce the pace of bond buying. A reduction in bond purchases would mark the BOJ’s first clear step toward quantitative tightening after moving away from its massive stimulus program in March and beginning a path to policy normalization. Although the bank states it does not target foreign exchange rates, a shift in debt purchases or a clear hawkish signal could help ease persistent pressure on the yen.

Market Reactions and Expectations

Ahead of the BOJ meeting, US data due Wednesday are expected to show a slowdown in inflation for May. Following this, the Federal Reserve is widely expected to keep its benchmark rate steady, with investors focusing on whether Chair Jerome Powell signals less scope for rate cuts later in 2024 after jobs data last week exceeded consensus estimates.

“The BOJ is in a tough spot,” said Izuru Kato, chief economist at Totan Research. “The scale of bond buying is still massive. If they are too cautious about cutting it, that could push the yen lower. At the same time, bond yields could rise sharply if they are too aggressive.” Ueda’s task of striking the right balance comes with higher pressure than usual this time. At his post-meeting press conference in April, the governor’s comments conveyed little sense of urgency over the yen, leading to a fresh 34-year low for Japan’s currency and prompting the finance ministry to conduct its biggest currency intervention on record.

“Ueda will shake politicians’ confidence in him if he does nothing at all to prevent the yen’s weakness from accelerating after his last press conference quickened the currency’s fall,” said Yuichi Kodama, chief economist at Meiji Yasuda Research. The yen weakened Monday to around 157 per dollar, following the US jobs data last week.

Bond Market Dynamics

While the BOJ has stated it no longer considers bond buying a monetary policy tool, market players are increasingly focused on its regular bond operations. The central bank rattled the market on May 13 by reducing its buying, and then faced a shortage of sellers in its operation on May 23 for the first time since 2013. This suggests that supply and demand conditions in the market are ripe for a paring back of purchases.

Bond redemptions this year are likely to reach ¥71.4 trillion, meaning that purchases below ¥5.95 trillion per month would result in a falling trend in the BOJ’s bond holdings, consistent with quantitative tightening, according to Taro Kimura at Bloomberg Economics. “Expect the BOJ to announce it will start reducing JGB purchases. That shouldn’t come as a shock – it has long flagged its willingness to shrink its balance sheet,” he said.

A wide range of Japanese bond yields have risen to the highest levels in a decade in recent weeks. Some analysts call for more central bank guidance on bond buying after the March end of the bank’s yield curve control program. As a result of its large-scale easing since 2013, the BOJ owns more than half of Japan’s outstanding public debt.

Street Views

• Izuru Kato, Totan Research (Neutral on BOJ's bond buying strategy):

  "The scale of bond buying is still massive. If they are too cautious about cutting it, that could push the yen lower. At the same time, bond yields could rise sharply if they are too aggressive."

• Yuichi Kodama, Meiji Yasuda Research (Bearish on Ueda's handling of yen weakness):

  "Ueda will shake politicians’ confidence in him if he does nothing at all to prevent the yen’s weakness from accelerating after his last press conference quickened the currency’s fall."

• Taro Kimura, Bloomberg Economics (Bullish on BOJ reducing JGB purchases):

  "Expect the BOJ to announce it will start reducing JGB purchases. That shouldn’t come as a shock – it has long flagged its willingness to shrink its balance sheet."

• Ryutaro Kono, BNP Paribas SA (Cautiously Optimistic on potential rate hike in July):

  "Ueda will probably take a stance of not ruling out a rate hike in July... But if he sounds too willing to do that, that could invite a surge in yields coming together with the bond buying reduction, so I expect Ueda’s remarks to be balanced."