MNI POLICY: BOJ Board Weighs Pace, Scale Of JGB Reductions

Bank of Japan board members are closely watching how the market reacts to lower Japanese government bond buying directed by the operations department to determine the future pace and scale of further board-driven reductions, MNI understands.

Operations has been tasked with reducing JGB buying within a certain range, depending on bond supply-demand conditions, but the department remains skeptical over sharply lowering purchases as the board maintained its JPY6 trillion a month target when it last met. (See MNI BOJ WATCH: Ueda Flags Policy Change On Weak Yen-Led Inflation)

Policymakers are focused on whether lower JGB buying causes long-term interest rates to surge, which would spoil economic fundamentals and endanger the BOJ’s goals. While they have largely agreed to lower the scale of buying, they have not reached consensus on its pace and scale as they cannot predict how the market will react.

The yield on 10-year JGBs rose to 0.975% on Monday, the highest level since May 2013, amid concern over lower buying and the potential for an earlier-than-expected rate hike. The BOJ lowered the scale of its JGB buying on May 13 to JPY425 billion for bonds with a five- to 10-year maturity from April 24's similar JPY475 billion operation.

The BOJ now wants to know whether it can reduce the scale of its total JGB operations down from about JPY5.8 trillion a month.

MNI reported last week some BOJ officials want to see stability return to the yen before any large scale JGB buying reductions. (See MNI POLICY: BOJ Wants Stable FX Market To Cut JGB Buying)

OPTIONS EXAMINED

Bank officials to not want to adopt a Federal Reserve-style “auto-pilot” system as this will limit the BOJ’s ability to address long-term interest rate surges through the policy rate, currently set to a range of zero percent to 0.1%.

Under existing conditions, the BOJ will have to increase JGB buying to curb higher bond yields, a counterproductive exercise.

But bank officials see the need to clarify the pace of lowering JGB buying to pave the way for market players to factor in future reductions smoothly.

The BOJ has also not determined by how much it can shrink its JPY590 trillion balance of JGBs. Bank officials realise the BOJ must maintain a relatively high current account balance, presently at about JPY550 trillion, although they have not determined the ideal level.

As the BOJ cannot sharply lower the current account balance, one solution could see the size of JGB holdings remain above the total level of banknote issuance of about JPY120 trillion plus some excess reserves, although the Bank has yet to determine the feasibility of this idea.

The BOJ board next meets between June 13-14.