Bank of Japan to Cut Bond Purchases, Maintain Current Interest Rates

 

TOKYO, June 14 (Reuters) - The Bank of Japan announced on Friday that it will start scaling back its large bond purchases and will release a detailed plan next month on how it plans to reduce its nearly $5 trillion balance sheet. This move is another step toward winding down its extensive monetary stimulus.

Governor Kazuo Ueda indicated that an interest rate hike in July is possible, especially as the weak yen drives up import costs. This suggests that despite recent signs of weak consumption and a slowing economy, the BOJ is maintaining a cautious, or hawkish, approach.

"Depending on the economic and price data available at the time, there's a possibility we could decide to raise interest rates and adjust the degree of monetary support in July," Ueda said at a news conference.

As expected, the BOJ kept its short-term policy rate target between 0-0.1% by unanimous vote and maintained its pace of monthly bond buying at about 6 trillion yen ($38 billion). However, the bank will provide details of its bond tapering plan for the next one to two years at its meeting on July 30-31, after gathering input from market participants. Some market observers had anticipated more specific clues on Friday

"In trimming bond buying, it's important to leave flexibility to ensure market stability while doing so in a predictable manner," Ueda said.

He mentioned that the size of the reduction would be "significant," but offered few specifics on the pace and degree of the cutbacks. "The BOJ probably wanted to lay the groundwork so that the tapering doesn't come as a surprise," said Katsuhiro Oshima, chief economist at Mitsubishi UFJ Morgan Stanley Securities.

"It's similar to how the U.S. Federal Reserve provided medium- to long-term guidance on tapering beforehand to avoid increasing uncertainty at each policy meeting," he added.

However, some market players interpreted the decision to wait until July as a sign that the central bank will be cautious in adjusting monetary policy. This dovish interpretation sent the yen to a more than one-month low of 158.255 to the dollar and pushed down the yield on the benchmark 10-year Japanese government bond (JGB) to 0.92%.

"Today's decision suggests that the BOJ is very careful about reducing the bond buying amounts, which means the central bank is also cautious about raising rates," said Takayuki Miyajima, senior economist at Sony Financial Group.

Weak Yen a Concern

The BOJ exited negative rates and bond yield control in March, marking a significant shift from a decade-long radical stimulus program. With inflation exceeding its 2% target for two years, it has indicated it will keep raising short-term rates to levels that neither cool nor overheat the economy, which analysts see as between 1-2%.

Many market participants expect the BOJ to raise rates again this year. In a Reuters poll conducted from June 3-7, nearly half of the economists predicted a hike in the July-September period, while another 43% expected it to happen in October-December.

The central bank has also been under pressure to start quantitative tightening (QT) and reduce its massive balance sheet to ensure the effects of future rate hikes smoothly feed into the economy. The BOJ's efforts to normalize monetary policy come as other major central banks, having already tightened monetary policy aggressively to combat soaring inflation, look to cut rates.

The Fed held rates steady on Wednesday and signaled the possibility of a single cut this year. The European Central Bank cut interest rates last week for the first time since 2019.

However, the normalization of Japan's still-loose monetary policy is complicated by weak consumption, casting doubt on the BOJ's view that robust domestic demand will keep inflation on track to consistently hit its 2% target.

Ueda acknowledged the recent signs of weak consumption but said spending is likely to increase with scheduled tax breaks, summer bonus payments, and rising wages boosting household income.

He also warned that the recent yen depreciation could have a significant inflationary effect by raising import costs, as companies are already steadily increasing prices for goods and services.

"Exchange rate movements have a big impact on the economy and prices," Ueda said. "Recent yen falls push up prices, so we are closely watching these moves in guiding policy."

Japan's weakening currency, down roughly 10% against the dollar so far this year, has become a headache for policymakers by raising import prices, which in turn boosts living costs and hurts consumption.

($1 = 157.9400 yen)

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