MNI POLICY: BOJ Examines Framework To Make JGB Operations Easier

The Bank of Japan wants to establish a broad framework that will make buying and selling JGBs easier, as the bank contemplates how it will execute a reduction to its purchases should the Board direct it to do so at July's meeting, MNI understands.

BOJ officials want a new system that ensures flexibility of daily operations and increases predictability for market participants should conditions warrant a strategy shift.

BOJ Governor Kazuo Ueda will take a cautious, step-by-step approach to avoid surprising market players with policy decisions. Ueda wants a framework that will minimize shocks and pave the way for market players to absorb volatility gradually, which is in contrast to the more policy decision-directed approach BOJ officials prefer.

Should the BOJ raise the policy interest rate to 0.25% at the July meeting, Ueda would consider a dovish framework to minimise the impact of the hike. (See MNI BOJ WATCH: Cuts To Bond Buys Detailed In July, Hike Eyed)

OPTIONS EXAMINED

The Governor recently noted publicly that the scale of JGB reductions will be sizable without elaborating, increasing speculation the bank could target about JPY12 trillion a year.

Regardless of the annual target, market conditions will drive monthly reductions. However, the scale could be smaller than expected as Ueda aims to temper financial market disruption.

The BOJ may also announce a large scale reduction over the next two years, but the bank would pledge to advance it step-by-step while monitoring the market impact each time.

Should the economy experience a serious shock before the bank has sufficiently raised policy rates to justify a cut, the BOJ would need to increase its JGB purchases to lower long-term interest rates to support the economy.

Bank officials cannot predict how high policy rates can rise from their current range of 0-0.1%, however, they believe the terminal rate is about 1.5% or slightly higher.

In February 2007 under Governor Toshihiko Fukui, the BOJ increased the policy rate to 0.50% after raising it to 0.25% in July 2006. The policy rate then fell to -0.1% in January 2016. The BOJ terminated the negative rate policy in March, its first hike since 2007.