MNI INTERVIEW: BOJ Needs 10-20 Years To Run Down Bond Holdings

The Bank of Japan is likely to take one or two decades to run down its bond holdings and reserves to normal levels, its former executive director Kenzo Yamamoto told MNI in an interview, adding that the Bank was in danger of falling behind the curve in raising rates.

There is no reason for the BOJ to hold such elevated amounts of long-term JGBs now that it has scrapped yield curve control policy, said Yamamoto, who expected the run-down to be drawn out over as long as 20 years given that the Bank is unlikely to conduct outright bond sales.

“Based on my provisional calculation, even if the BOJ stops buying JGBs, it will take nine to 10 years for the BOJ to lower its current account balances, currently JPY561 trillion, to the normal level of about JPY20-JPY30 trillion,” he said in an interview.

The BOJ said in June that it could announce a detailed plan for reducing purchases of long-term government bonds by as early as its July meeting. Its bond holdings totalled JPY586 trillion at the end of March, many times the JPY121 trillion stock of banknotes. (See MNI POLICY: BOJ Examines Framework To Make JGB Operations Easier)

But the BOJ must be cautious, in order to avoid surges in market interest rates, said Yamamoto, now the representative of KY Initiative. One possibility would be for the BOJ to first reduce monthly bond purchases to JPY5 trillion, before cutting them to JPY3 trillion in two years, he said, adding that the Bank should also shorten the maturity of the debt it purchases in order to run the bonds off its balance sheet more quickly.

BEHIND THE CURVE

Monthly purchases of JPY3 trillion per month would be outpaced by maturities, reducing holdings by JPY36 trillion every year, meaning the BOJ would need 13 years to lower the size of its balance sheet by JPY470 trillion to more appropriate levels, he said.

While the Bank moves gradually to reduce its bond holdings, it is in danger of being too slow to raise rates, said Yamamoto, who doubts whether the virtuous cycle between wages and prices which the BOJ is waiting for before tightening further will materialise. (See MNI INTERVIEW: BOJ July Hike Probability 40% - Kameda)

“Real wages fell 1.4% y/y in May, widening from -1.2% in April. Judging from continuously negative real wages, it cannot possibly say the virtuous cycle is strengthening. It’s a vicious cycle,” Yamamoto said, adding that the appropriate response would be to tackle the inflation which has eroded purchasing power for 26 straight months.

“Lowering prices is orthodox monetary policy,” Yamamoto said.

Any initial reduction in bond sales in July would only be small if the BOJ also chooses to raise its policy rate again at the same time, he added.

“The capacity of commercial banks to buy JGBs may be large, as they may be willing to increase JGB holdings while reducing holdings of foreign bonds,” Yamamoto said, noting the relatively subdued market reaction to the BOJ’s announcement that it intended to reduce bond buying by a “sizable” amount.

“Some banks that are suffering from unrealised losses of foreign bonds will not sell those bonds immediately as they must incur losses. But they must seek chances to buy JGBs after their maturities.”