BOJ may drop clues on bond tapering plan next week, sources say

TOKYO, June 10 – Bank of Japan policymakers are brainstorming ways to slow its bond buying and may offer fresh guidance as early as next week, sources familiar with its thinking said, in what would be a first key step to reducing its almost $5 trillion balance sheet.

While details are not finalised, the central bank could trim monthly purchases or clarify plans to proceed with a slow but steady taper with a focus on preventing abrupt yield spikes, the four sources said.

Any such decision could lay the groundwork for the BOJ, which lags way behind counterparts in tightening monetary policy, to shrink its 750-trillion-yen ($4.8 trillion) balance sheet that is nearly 1.3 times the size of Japan’s economy.

The topic will likely take centre stage at the BOJ’s next policy meeting on June 13-14. The board may delay a decision, however, if Japan’s bond market faces renewed volatility, they said.

“The BOJ has already decided to taper at some point, so it’s only a question of timing,” said one of the sources.

“Much will depend on market conditions at the time, as the key would be to avoid causing market turbulence,” another source said, a view echoed by two more sources. The sources spoke on condition of anonymity due to the sensitivity of the matter.

At next week’s meeting, the BOJ is expected to maintain short-term interest rates in a 0-0.1% range as it awaits more data showing wage hikes broadening and inflation durably at its 2% target, the sources said.

Conditions seem to be falling into place for tapering. After hitting a 13-year high of 1.1% last week, the 10-year Japanese government bond (JGB) yield is now below 1%, in line with falling U.S. Treasury yields.

But market risks persist, including Friday’s U.S. nonfarm payrolls data and the Federal Reserve’s policy-setting meeting on Wednesday.

‘CONSTRUCTIVE AMBIGUITY’

In March, the BOJ ended eight years of negative interest rates and yield curve control (YCC), a policy that caps the benchmark 10-year yield around 0% with huge bond buying.

But it pledged to keep buying roughly 6 trillion yen worth of government bonds per month – just enough to maintain its balance sheet.

Three months after that decision, the board will debate whether markets are ready for a full-fledged tapering in bond purchases, the sources said.

A further cut would mean the BOJ moves to quantitative tightening (QT), reducing a balance sheet that is now five times the Fed’s in ratio-to-GDP terms.

BOJ Governor Kazuo Ueda has repeatedly said the bank will eventually slow bond purchases, a stance he reaffirmed on Thursday, but has given no clues on timing.

The topic was debated at the BOJ’s April policy meeting with some members calling for reduced bond buying or guidance on how the bank would do so, according to a summary from the meeting.

Underscoring their desire to start tapering, Ueda and his deputy Ryozo Himino both said on Tuesday that bond yields ought to be driven by market forces.

Himino, however, also said the BOJ needed to be wary of “discontinuity” and unintended consequences.

The BOJ could gradually reduce bond buying, while making clear it stands ready to step in with emergency purchases if bond yields rise too quickly, the sources said.

However, for the BOJ, tapering is made harder by markets becoming accustomed to its heavy-handed intervention that has kept borrowing costs ultra-low.

A dire fiscal situation also means the BOJ must avoid sharp yield spikes that would boost financing costs for Japan’s huge public debt.

As such, the BOJ likely won’t follow the Fed, which set a fixed schedule to shrink its balance sheet under a pre-determined plan from a peak of nearly $9 trillion yen to $7.4 trillion as of March.

Preferring a more discretionary approach, the BOJ will likely offer looser guidance on tapering, instead of providing a detailed timetable spanning years, the sources said.

“Constructive ambiguity is key here,” said former BOJ official Nobuyasu Atago. “The BOJ will probably choose language that leaves itself flexibility to adjust the pace of tapering, while allowing long-term yields to rise gradually.”