Kristian Rouz — The Bank of Japan (BOJ) is expected to slightly change its policies in the coming days, a move that could produce spillover effects in bond markets across the globe. Speculation is rife as the Japanese central bank could scale back its bond-buying program and reduce its bond holdings.
Such measures would signal a likely first step in a broader policy tightening, which could encourage the Japanese firms to bring their capital back home.
Such measures would suggest that the BOJ is gradually moving towards exiting its negative and zero interest rate policies (NIRP and ZIRP, respectively), in order to counterbalance ongoing monetary tightening in the US and the UK, which has made these economies more attractive investment destinations.
This comes as Japanese investors hold $2.4 trillion in foreign bond assets, which they could start to liquidate in favor of domestic assets due to the BOJ's tightening policy.
"The BOJ is likely to cut bond purchases more drastically and more flexibly, which targets the super-long sector, to revive market liquidity and volatility," Jun Ishii of Tokyo-based Mitsubishi UFJ Morgan Stanley Securities Co. said.
However, the BOJ is still facing the challenge of low inflation, meaning the central bank is unlikely to implement decisive measures to remove its unconventional stimulative policies. The BOJ is expected to allow more interest rate flexibility in order to support lending activity.
Additionally, the BOJ could also ramp up its purchases of Japanese stocks — this could boost the capitalization of Japanese companies and spur business activity.
But the overall monetary stimulus is going to remain in place for as long as it takes to bring Japan's inflation rate in line with the central bank target of 2 percent. Inflation faltered at 0.7 percent in June after spiking at 1.5 percent back in February — which was largely achieved due to expensive energy imports during the cold winter season.
"We believe the BOJ will not change monetary policy by daily operations without an official announcement through its policy statement," Yoshinori Shigemi of JP Morgan Asset Management Ltd. said.
This is holding back GDP growth, and the BOJ is looking at modifying its yield-curve control (YCC) guidance. Currently, the YCC is focusing on keeping short-term bond yields at —0.1, and 10-year yields at zero. But the BOJ could relax its yield control, allowing investment flows to determine the natural interest rate — and follow suit with appropriate actions.
Some BOJ policymakers argue that this would encourage domestic investment, as upbeat economic growth projections would prompt investors to sell safe-haven longer-term bonds and allocate capital into riskier and more lucrative assets across several sectors, including services and manufacturing.
This, in turn, could translate into higher inflation, alleviating some of the central bankers' concerns of the perceived unsustainability of the BOJ's current policy course.