BoJ to start quantitative tightening which could support Yen more than intervention

The Bank of Japan (BoJ) revealed at the June policy meeting the intention to reduce JGB purchases after the July meeting. While Governor Ueda stated that amounts could be substantial, details should only be unveiled at the BoJ’s meeting in July. The announcement of quantitative tightening (QT) marks a further departure from the unconventional monetary policy developed under former Governor Kuroda, with important implications for Japanese Government Bond (JGBs) yields and the Yen.Against such backdrop, the critical question is how quickly the BoJ will reduce its balance sheet by limiting JGB purchases. If one takes the extreme case of BoJ going back to the purchases prior to Kuroda, this implies reducing the purchase from JPY 6 tr to JPY 2 tr (Chart 1). At the same time, the redemption of JGBs is estimated at about JPY 6 tr per month, as the BoJ’s holdings have been flat at around JPY 600 tr while the Bank purchased about JPY 6 tr*. Hence, this scenario implies that the BoJ’s JGB holdings would be reduced by JPY -48 tr per year, or -8.0% of total JGB stock on the BoJ’s balance sheet. This is a very fast reduction of the BoJ’s balance sheet, even faster than the ECB, which decreased government bond holding on its balance sheet by -7.3% YoY in May.We are, thus, expecting the BoJ to take a more gradual approach especially at the initial stage. This is in line with the very slow movement away from ultra-lax monetary policy so far. In fact, nothing was announced at the BoJ’s June meeting other than a plan to taper in July.  Meanwhile, the BoJ has been testing the waters by meeting groups of banks, security firms, and asset managers. Therefore, a more gradual reduction from JPY 6 tr monthly purchase to JPY 4 tr per month is much more likely. This would account to a decrease in JGB holdings by -4.0% per year.While the tapering could lift the 10-year JGB yield to about 1.5%, the BoJ is anticipated to keep its options open and, thus, purchase more JGBs if the yield shoots up. On the other hand, the US Treasury yield is expected to fall as the Fed becomes more dovish on the back of softening inflation. With a shrinking interest rate differential between the US and Japan, the BoJ’s QT should help support the Yen possibly hovering around 150 against the USD toward the end of the year (Chart 2).*JGB holding (t+1) = JGB holding (t) + JGB purchase (t) – JGB redemption (t)