MNI POLICY: BOJ QT Impact Will Increase As Holdings Reduce

Bank of Japan officials are examining whether quantitative tightening could send long-term interest rates above a theoretical level based on the past effect of quantitative easing, with concern growing the impact could increase as the BOJ reduces its considerable portfolio, MNI understands.

The Bank held about 53.25%, or JPY586 trillion, of outstanding JGBs at the end of March, with the stock effect from the portfolio estimated to have lowered the 10-year interest rate by 100 basis points from the pre-Quantitative and Qualitative Monetary Easing (QQE) 2013 level.

While the stock effect will not wane immediately should the BOJ commit to QT due to the sheer size of the portfolio, bank officials are worried any tightening could put upward pressure on long-term interest rates, with some theorising a 10% reduction could increase them by 10bp. The impact could also grow as the BOJ’s bond-holding ratio falls compared to overseas central banks.

The BOJ said in June it could announce a detailed plan for reducing purchases of long-term government bonds by as early as its July 31 meeting. (See MNI POLICY: BOJ Examines Framework To Make JGB Operations Easier)

ASYMMETRIC EXPERIENCE

U.S. Federal Reserve analysis has shown QT's impact on long-term interest rates is smaller than QE. However, the Fed is carefully reducing its holdings, while focusing on the degree that will trigger a rise in long-term interest rates and despite the unknown level of ample reserves.

Once the BOJ announces the scale of its bond reductions, interest rates could rise preemptively if the market expects a higher terminal rate or faster hikes, but before the Bank reduces its holdings to a significant level.

However, the BOJ's current account balance remains considerably higher than the ample-reserve level, making officials less concerned in the short term.