MNI BOJ INSIGHT: Want to Slow JGB Buying But Wary of Yen Risk

--BOJ Wants To Slow 3-5 Yr, 5-10 Yr Purchases But Only If No Yen Rise

By Hiroshi Inoue

     TOKYO (MNI) - The Bank of Japan wants to slow the rise in its Japan

government bond holdings to make an eventual unwinding of its aggressive easing

policy smoother but is being extra careful to ensure that smaller JGB purchases

do not ignite a rise in yen exchange rate, MNI understands.

     The BOJ has been seeking an opportunity to lower the size of its purchases

of JGBs with a remaining life of 3- to 5-years and 5-to-10 years, returning the

purchase sizes to the levels seen before the BOJ raised them earlier this year

to stem rises in yields, according to sources familiar with BOJ thinking.

     The easing of tensions over North Korea's nuclear threat has led to a drop

in bond yields from their elevated levels caused by safe-haven buying. This

provides an environment for the BOJ to lower the size of its purchase of medium-

and long-term government bonds to their previous levels.

     However, the BOJ is on guard because it knows that reducing the pace of

asset purchases could easily prompt buying of the yen against the dollar on the

assumption that the interest rate differential between Japan and the U.S. would

narrow.

     The BOJ does not want a sharp and fast appreciation of the yen, the net

effect of which would be negative for both the economic recovery and a pickup in

inflation, as any exchange rate rise would trim exporter profits and so tend to

push down domestic share prices.

     The dollar has been relatively stable around Y109 recently and Japanese

officials are comfortable if the dollar stays in a range of Y105 to Y115. A

dollar drop below Y100 would be alarming for exporter profits while a dollar

rise above Y120 would also be troubling as it would push up the cost of imports

for households and small businesses.

     In keeping with its yield-curve control policy, the BOJ would cut the size

of its JGB purchases with a remaining life of 5- to 10-years if the 10-year JGB

yield were to fall far below the policy target of around zero percent.  With

current long-term yields above, but close to, the target, the BOJ would consider

cutting its purchases if market conditions are appropriate.  

     The BOJ plans to buy JGBs in that zone Friday as part of its regular market

operations for August announced at the end of last month. In its previous

operation in the 5- to 10-year zone last Friday, the purchase amount was left

unchanged at Y440 billion.

     The BOJ first increased the scale of its purchases in the 5- to 10-year

zone in early July after the 10-year yield rose to 0.105%, well above the BOJ's

target. It raised the per auction purchase amount to Y500 billion on July 7 from

the Y450 billion level that had been in place since Jan 27.

     On July 24, it reduced the pace to Y470 billion after the 10-year yield

fell to 0.065%, cutting it further to Y440 billion on Aug. 16 after the

long-term interest rate slipped to 0.040%.

     The 10-year yield fell further to 0.030% on Aug. 18, the lowest level since

May 10. It ended Wednesday's session at 0.035%, unchanged from the previous day.

     In the 3- to 5-year JGB zone, the BOJ gradually lowered the scale of its

purchases per auction from Y420 billion in February to Y300 billion on May 1,

but reversed course and increased the pace to Y330 billion on July 12 in a move

to counter a rise in the 5-year JGB yield to -0.035%.

     Under its latest policy framework, the BOJ is seeking to stabilize the

10-year government bond yield, the benchmark for long-term borrowing costs,

around zero percent and keep the overnight interest rate at -0.1%. There is no

policy target for other zones along the flat yield curve, though their yields

are meant to fit into the BOJ's view of an appropriate yield curve.

     The yield on 5-year bonds fell to -0.100% on Tuesday, a level that is be a

little too low for the shape of the yield curve and thus may prompt the central

bank to eventually consider cutting the size of its medium-term bond purchases

back to Y300 billion.

     However, at Wednesday's auction, the BOJ left the scale of its 3- to 5-year

purchases unchanged at Y330 billion because the yield on the 5-year JGB has been

stable and there was no indication at the time of market operation that the

yield would fall sharply. The 5-year yielded ended the day at -0.100%, unchanged

from Tuesday.

     BOJ officials believe that market participants understand that the recent

slowdown in central bank purchases of JGBs is due to the stability of bond

yields and that the BOJ is not yet tapering off its accommodative policy.

     If upward pressure on JGB yields were to grow due to the influence of

higher overseas bond yields, the BOJ would increase the scale of its purchase of

government debt to rein in JGB yields. Otherwise, the BOJ wants to reduce the

scale of its purchase of JGBs and the stem the rise in its bond holdings, if

market conditions allow the BOJ to do so.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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