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Japan’s central bank said it will begin “significantly” scaling back its 6 trillion yen ($38 billion) monthly bond-buying program, a critical milestone in unwinding its ultra-loose monetary policy and shrinking its enlarged balance sheet.
It weakened almost 0.8 percent to 158.26 yen against the dollar on Friday, the lowest level since several government interventions from late April to May, after the Bank of Japan delayed details of tapering purchases until next month.
“It is appropriate to limit bond purchases in a predictable manner while ensuring flexibility for market stability. If we are to start reducing [the purchases]we believe the size will be significant,” BoJ Governor Kazuo Ueda told a news conference, adding that the specific amount and pace of tapering would be outlined after hearing market participants’ views.
Ueda faced pressure from a falling yen as weak domestic consumption made it harder for the central bank to narrow the gap between Japan’s borrowing costs and higher U.S. interest rates.
The U.S. Federal Reserve indicated this week that it plans to make just one cut in interest rates this year, which are at 23-year highs, while maintaining its hawkish stance.
The BoJ said in a statement that its decision to limit purchases of Japanese government bonds over the next one to two years – opposed by one board member – was to “ensure that long-term interest rates are formed more freely in the financial area.” markets”.
The BoJ also said it would keep its overnight interest rate between zero and 0.1 percent, a widely expected move. The bank ended its era of negative interest rates in March and raised borrowing costs for the first time since 2007.
Even as the BoJ begins to taper its JGB purchases, it is unlikely to make any bold moves towards quantitative tightening, such as suspending asset purchases or even asset sales. Instead, officials think they can use the uneven maturity schedule to gradually reduce the portfolio even as they keep buying new bonds.
Annual amounts due from the portfolio will reach approximately ¥70 trillion over the next few years. With the BoJ buying bonds at barely that pace, small adjustments to the buying plan could lead to a decline in the portfolio.
Goldman Sachs expects the BoJ to gradually reduce the volume of its monthly JBG purchases from 6 to 5 trillion yen. As part of its very loose monetary easing program, the BoJ’s holdings of JGBs rose to 593 trillion yen at the end of May from 91 trillion yen 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, reaching 1.1 percent. That has led some investors to expect the BoJ to announce this week how much it will begin to cut bond purchases.
“The recent decline in the yen is a factor pushing prices up, so we are closely monitoring its impact on our policy management,” Ueda said.
Izuru Kato, a longtime BoJ watcher and chief economist at Totan Research, said the BoJ faces greater challenges than its US and European counterparts in specifying the pace of tapering. Japan’s debt, around 2.5 times the size of its economy, is vulnerable to any rise in yields caused by the BoJ’s rapid tapering of bond purchases.
“The BoJ has ended its policy of negative interest rates and yield curve controls, but markets assume it will not be able to raise rates quickly and needs to be cautious about quantitative tightening due to massive JGB issuance,” Kato said. he added that changing market expectations would require a much more aggressive plan to reduce JGB purchases.
Investors now expect the BoJ to raise rates modestly in July, although the yen’s weaker impact on consumption has made it difficult for the central bank to confirm the benign cycle between rising wages and prices.
On Friday, Ueda did not rule out a rate hike at the same time the bank offers details of its bond-cutting plan in July, but warned that his decision would be guided by available economic data.
“If the BoJ continues to maintain accommodative conditions, it will only weaken further and real wages will not turn positive,” Kato said. “The BoJ is stuck in a difficult loop.
Additional reporting from Leo Lewis in Tokyo and William Sandlund in Hong Kong