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Bearish Correction Still In Play

Repeats Story Initially Transmitted at 05:10 GMT Sep 5/01:10 EST Sep 5
By Hiroshi Inoue
     TOKYO (MNI) - The Bank of Japan is taking advantage of tight bond market
conditions and geopolitical risks to scale back its buying of Japanese
government debt to make it easier to eventually exit from massive monetary
stimulus, but the central bank does not consider the current slowdown in JGB
purchases as a "tapering" of current easy policy, MNI understands.
     The BOJ stands ready to further reduce the scale of its purchase of
Japanese government bonds if market conditions allow it to do so.
     BOJ officials define tapering as "reducing the scale of bond buying as a
policy objective," not the current "passive" cuts in JGB purchases in response
to recent market conditions.
     However, BOJ officials see the recent slowdown in the bank's asset
purchases aimed at preventing bond yields from falling too fast as the BOJ
"taking advantage" of current market conditions to allow it to plan ahead for
its eventual exit from aggressive easing.
     With inflation still just above zero and far below the bank's 2% target, it
is uncertain how long it will be before the process of unwinding of asset
purchases begins. The bank has to confirm first that inflation is anchored
around 2% and the economy is unlikely to slip back into deflation.
     "Reducing the scale of JGB buying mainly in response to a drop in bond
yields is a passive cut and isn't equivalent to so-called tapering and an active
cut" in bond buying, said a person familiar with BOJ thinking. "The BOJ will not
be able to consider actively reducing the scale of bond buying before the
achievement of its 2% inflation target."
     The person, however, added that if market conditions warranted, the BOJ
would reduce further the pace of its bond purchases to slow the rise in its JGB
holdings, which in turn would make the eventual unwinding of its aggressive
easing policy smoother.
     The BOJ has increased or reduced the scale of its purchases of JGBs
depending on fluctuations in JGB yields.
     On Aug. 25, the BOJ reduced the size of its purchases of JGBs with a
remaining life of five to 10 years to Y410 billion per operation from Y440
billion, after cutting it from Y470 billion on Aug. 16 and from Y500 billion on
July 24.
     This reversed the increase in the buying in this zone to Y500 billion from
Y450 billion that occurred on July 7.
     On Sept. 1, the bank slowed the pace of its purchase of JGBs with a
remaining life of three to five years to Y300 billion from Y330 billion.
Purchases in this zone had been gradually reduced from Y420 billion at the
beginning of this year to Y300 billion by May 1 but were increased to Y330
billion on July 12 in response to market conditions.
     While shifting its monetary easing target to controlling the relatively
flat yield curve at near zero levels last September, the BOJ has maintained the
guideline for JGB purchases at an annual pace of about Y80 trillion.
     However, the annualized pace of the BOJ's purchases of JGBs slowed to Y65.4
trillion in August from Y77.7 trillion in February as a result of the slower
pace of purchases, according to MNI calculations based on BOJ data.
     The amount of JGBs purchased by the BOJ in August totaled Y7.8 trillion, up
from Y7.45 trillion in July but down from Y9.72 trillion in April, Y8.57
trillion in March, Y9.55 trillion in February and Y9.71 trillion in January.
     Another person familiar with BOJ thinking said that it remains uncertain
whether the BOJ will continue to reduce the scale of its bond buying every month
because any reduction depends on how bond yields behave.
     The person, however, said that the BOJ is willing to reduce the scale of
its bond buying if it can do so without pushing down stock prices or causing the
yen to rise sharply.
     A drop in bond yields would be the key reason for the BOJ to reduce its
bond-buying operations further, but BOJ officials would be careful to ensure
that any action they take would not upset the markets. Reducing the scale of
bond purchases when investors were in a risk-off mood could trigger a yen rise,
and thus a drop in domestic stock prices.
     This month, the BOJ has lowered its purchase plans for JGBs with a
remaining life of five to 10 years to a range of Y300 billion to Y500 billion
per operation from a range of Y350 billion to Y550 billion in August.
     The bank extended the lower end of the range to give itself more leeway in
operations. The BOJ is currently buying Y410 billion of JGBs with a remaining
life of five to 10 years per operation. The previous lower end of Y350 billion
was only Y60 billion below the current pace but there is a wider Y110 billion
margin to the new end of Y300 billion.
     BOJ officials are more vigilant against downward pressure on JGB yields
than on upward pressure because of continued tight supply-demand conditions
backed by BOJ buying and banks' need to buy new bonds before existing issues
mature. There is also safe-haven buying of fixed-income securities amid
geopolitical risks heightened by the threat of North Korean nuclear weapons and
missile attacks.
     At the same time, they are also prepared to respond to a jump in bond
yields by increasing temporarily the scale of bond purchases.
     BOJ officials remain cautious about removing the wording from the statement
released after policy meetings that sets out the bank's annual JGB purchase
guideline at "about Y80 trillion," even though it is no longer the main policy
target.
     They believe removing the wording could have an unexpected unfavorable
impact on financial markets by creating the incorrect impression among market
participants that the BOJ had begun tapering policy.
--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
--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com