The BOJ is universally expected to keep rates unchanged at its policy meeting this week. But what could affect the markets is if it changes its bond buying targets. There is substantial speculation that the BOJ could announce a change in its taper off of JGB buying which would be equivalent to a move towards easing.
The yen has strengthened substantially (or maybe it’s more accurate to say the dollar has weakened) so the exchange rate isn’t a major concern for Japanese policymakers at the moment. The slow economic growth and high inflation situation, whoever, poses a significant challenge to the central bank. This means it could be forced to get creative in terms of policy and market signalling, such as talking up rate hikes at the same time as taking easing steps with its bond buying.
The Taper Timing
Since Kazuo Ueda took over the top job at the BOJ, it has been working towards “normalizing” central bank policy. That means ending the years of ultra-easing that has characterized Japanese monetary policy since the early ’90s.
First was a move to start tapering off the amount of JGBs the bank was buying, followed by moving out of negative interest rates. Typically, a central bank does not want to be active in the market buying or selling bonds. Normalizing policy, therefore meant that the BOJ would slowly reduce the amount of government bonds it was buying, allowing the interest rate to rise. This in turn would be expected to strengthen the yen.
The Disruption That Changes the Timing
The BOJ is scheduled to reduce its current bond buying program by ¥400 billion next year, as part of a very slow normalization process. Banks and financial institutions in Japan had become so accustomed to ultra-low rates that the BOJ has to be very cautious in stepping back from the market to prevent runaway interest rates. Even with high inflation, the BOJ can’t raise rates too fast so as to avoid a collapse in the bond market.
Markets, however, seem to sense this and this leaves inflation expectations to rise beyond what the central bank wants. As a result, consumer prices in Japan are well above target, with the BOJ unable to raise rates. Particularly as the economy slows down.
The Uncertainty Play
Ueda and his colleagues can point to the market being disrupted by the tariffs, generating uncertainty that means the BOJ has to hold rates lower despite higher inflation. But it also means that the BOJ is justified in not reducing its bond buying at the same rate.
This is why many analysts are expecting the BOJ to announce it will taper by ¥200 billion next year, as this would have a mildly accommodative effect on the market. At the same time Ueda could keep talking tough on interest rates in an effort to jawbone inflation into compliance. The end result of all of that could actually just leave the yen trending sideways.