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The Bank of Japan said it would “significantly” scale back its monthly bond-buying program worth ¥6 trillion ($38 billion), a crucial milestone in winding down its ultra-loose monetary policy and trimming its expansive balance sheet.
The yen weakened nearly 0.8 percent to ¥158.26 against the dollar on Friday, the lowest level since multiple government interventions from late April to May, after Japan’s central bank postponed details of its purchase cuts until next month.
“It is appropriate to reduce bond purchases in a predictable manner while ensuring flexibility for market stability. If we want to start cutting back [the purchases]We believe the magnitude 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 falling yen as weak domestic consumption has made it difficult for the central bank to narrow the gap between Japanese borrowing costs and higher US interest rates.
The US Federal Reserve this week signaled plans to make just one cut this year to interest rates that are at a 23-year high, 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 the financial sector. markets”.
The BoJ also said it would keep its overnight interest rate within a range of around zero to 0.1 percent, a widely expected move. The bank ended the era of negative interest rates in March, raising borrowing costs for the first time since 2007.
Even as the BoJ begins to taper its purchases of Japanese government bonds, it is unlikely to make a bold shift toward quantitative tightening, such as suspending asset purchases or even asset sales. Instead, officials think they can take advantage of an uneven maturity schedule to gradually reduce the portfolio even as they continue to buy new bonds.
The annual amounts maturing from the portfolio will be approximately ¥70 trillion in the coming years. With the BoJ buying bonds at barely that pace, small adjustments to the purchasing schedule could send the portfolio into decline.
Goldman Sachs expects the BoJ to gradually reduce the amount of its monthly JBG purchases from ¥6 trillion to ¥5 trillion. Under its ultra-loose monetary easing programme, the BoJ’s holdings of Japanese government bonds increased to ¥593 trillion at the end of May, from ¥91 trillion at the end of March 2013.
In May, the BoJ surprised markets by buying a smaller-than-expected number of five- to 10-year government bonds during its regular activities. Since then, long-term interest rates have risen to the highest level since July 2011, namely 1.1 percent. That had prompted some investors to anticipate that the BoJ would announce how much it would cut its bond purchases this week.
“The recent decline in the yen is a factor pushing up prices, so we are closely monitoring 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 taper. Japan’s government debt, which is about 2.5 times the size of the Japanese economy, is vulnerable to a rise in interest rates due to a rapid reduction in bond purchases by the BoJ.
“The BoJ ended its policy of negative rates and yield curve control, but markets are assuming it will not be able to raise rates anytime soon and will need to be cautious about quantitative tightening due to massive government bond issuance,” he said. Kato. adding that changing market expectations would require a much more aggressive plan to reduce JGB purchases.
Investors now expect the BoJ to implement a small rate hike in July, although the impact of the weaker yen on consumption has made it harder for the central bank to confirm a positive cycle between rising wages and prices.
On Friday, Ueda did not rule out a rate hike at the same time the bank announced details of its bond reduction plan in July, but warned his decision would be guided by available economic data.
“If the BoJ maintains persistently accommodative conditions, the yen will weaken further and real wages will not turn positive,” Kato said. “The BoJ is stuck in a difficult circle.”
Additional reporting by Leo Lewis in Tokyo and William Sandlund in Hong Kong