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The Bank of Japan said it would begin scaling 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 to ¥157.89 against the dollar on Friday, the lowest level since multiple government interventions from late April to May, after the Japanese central bank put off outlining a more specific plan for cuts to its bond purchases until next month.
BoJ governor Kazuo Ueda has faced pressure from the yen’s decline as weak domestic consumption has made it difficult for the central bank to raise interest rates fast enough 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 continue to guide the 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 — to avoid major disruption to financial markets.
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.
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,” Kato said.
Investors now expect the BoJ to carry out another 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.
“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
