The BOJ may heed calls to stop the bond taper next year

Written by Leika Kihara

TOKYO, May 29 (Reuters) – Volatility in bond markets is fueling calls for Japan’s central bank to suspend the release of a large amount of its debt next fiscal year, giving Prime Minister Sanae Takaichi a reprieve amid investor concerns about his spending plans.

The pause will mark a turning point in the Bank of Japan’s rate tightening (QT) program – on track from 2024 as part of Governor Kazuo Ueda’s efforts to unwind a decade-long, massive stimulus.

At its June 15-16 meeting, the BOJ will review its bond reduction plan that runs through March next year and set a new fiscal plan for 2027.

With no change expected in the current taper plan, markets are focused on whether the BOJ will continue to reduce its monthly bond purchases through fiscal 2027 or maintain the current pace.

While there is still no consensus among the BOJ on a final decision, a temporary pause in the taper is increasingly seen as the preferred option with uncertainty over the Iran war keeping bond markets volatile, two sources familiar with the discussions said.

“Markets are always volatile, so there is no need to rush,” said one of them on the BOJ’s taper, adding that many market players seem to like to maintain the current pace of purchases.

Political considerations may also prompt the BOJ to pause as rising bond yields threaten to block Takaichi’s spending plans.

“The thing that management wants to avoid the most is a rise in bond yields,” said one of the sources.

PETITIONS TO STOP HIM ARE GROWING

Some investors are now asking the BOJ to slow down its bond program, a central bank survey earlier this month showed, highlighting the challenge it faces in reducing its massive Japanese government bonds (JGB).

There were already indications that the BOJ may consider reducing its taper plan amid market uncertainty.

A clear signal on the BOJ’s taper plan will come next week, when the central bank releases the minutes of its meeting with bond market participants held on May 21-22.

“We have seen a rapid rise in bond yields, which makes it difficult for investors to buy bonds. The finance ministry may be worried,” said former BOJ chief Nobuyasu Atago.

“Due to the tension in the political situation, I see no reason for the BOJ to continue recording in the next fiscal year,” he said.

Worries over Japan’s weakening currency and rising inflation pushed the 10-year JGB yield to a 30-year high of 2.8% last week, closer to the 3% target the finance minister set in its 2026 fiscal budget. An increase of more than 3% would increase the cost of servicing debt and reduce the scope for other spending.

The BOJ’s rate hike decision may also affect its taper plan with an increase in short-term rates to 1% from the 0.75% seen as most likely at the June meeting.

Although the central bank has said its taper plan has no monetary policy implications, the case for reducing QT gets stronger if it goes up, analysts say.

“Since the bond market is unstable, it would be natural for the BOJ to play it safe and avoid causing undue market turmoil,” said Mari Iwashita, senior rate strategist at Nomura Securities, who plans to freeze 2027 funds.

“A combination of a pause and a rate hike would be good,” as the former would ease upward pressure on yields, while this would ease concerns that the BOJ is behind the curve in dealing with inflation risks, he said.

POLITICAL SOLUTIONS

Rising debt and volatile yields have increased the challenges for central banks that are unwinding their ballooning balance sheets from years of heavy asset purchases to repair their economies.

In the US, analysts doubt whether new Federal Reserve chief Kevin Warsh can pass on his calls for a smaller balance sheet as US Treasuries lose their luster.

The BOJ also kept an eye on its QT plan that started in 2024, where it is gradually reducing purchases and is currently reducing monthly purchases by 200 billion yen per quarter.

Political obstacles to the BOJ’s QT have grown under Takaichi, who has vowed to cut taxes and boost spending through debt-backed financing.

Taper or not, the BOJ’s asset reduction, currently estimated at 500 billion yen, will continue slowly due to the glut of aging JGBs that have already stripped 20% of their balance sheet from their peak in late 2023.

This is all the more reason for the BOJ to maintain the current pace of purchases, said former BOJ chief Akira Otani, currently a managing director at Goldman Sachs Japan.

“When inflation risks from conflicts in the Middle East and active government monetary policy are putting upward pressure on bond maturities, continued downgrades could cause political tensions by raising yields,” he said.

(Reporting by Leika Kihara; additional reporting by Tamiyuki Kihara, Makiko Yamazaki and Takahiko Wada; Editing by Sam Holmes)