June 16 2017, 21:00 JST

Kuroda gives his two cents on BOJ tapering strategy

The Bank of Japan (BoJ) kept all its numerical policy target unchanged when it concluded its two day policy meeting on June 16. Before the decision, there was some speculation that the BoJ may delete or change the statement pertaining to the 80 trillion-yen annual pace of increase in its JGB holding. However, as most expected, the BoJ kept the phrase intact. The BoJ made a minor upward adjustment in its economic assessment. In the June policy statement, it said that “the Japanese economy is turning toward expansion”, an upward revision from “continuing to recover” expression in the previous statement. Two policy board members, Mr Sato and Mr Kiichi, objected to the decision and suggested smaller asset purchases, but they were voted down. All in all, the BoJ seems happy to carry on as it has in the past 9 months. 

In the press conference following the decision, the Governor Kuroda seemed more relaxed than he was in the past few meetings. We can understand why he should be, as we also see that economic indicators released recently tend to support the view Mr Kuroda has been insisting, namely, that the Japanese economy is continuing to progress toward achieving its inflation goal. 

During the press conference, reporters repeated pressed Mr Kuroda on two issues. One was on the BoJ’s guideline for its purchase of JGBs. In recent months, it has become increasingly clear that the BoJ is reducing the pace of its JGB purchase. In May, the BoJ purchased 7.2 trillion yen of JGBs, down from the recent peak of 11.6 trillion yen in April 2016. 

BoJ’s monthly purchase of JGB has been falling

As a result, the annual pace of increase in BoJ’s JGB holding have fallen to slightly below 70 trillion yen. 

Amount of JGBs in Bank of Japan’s balance sheet 

Note: As of June 10 for June in the chart. 

When reporters asked if the BoJ intends to change the “about 80 trillion yen” phrase in the policy statement, Mr Kuroda’s answer seemed to imply that any number, including the number as low as 20 trillion yen, can be fitted into the range offered by "about 80 trillion yen”. In our view, the BoJ will probably remove “80 trillion yen” from the statement when the reduction of the JGBs purchase has become so-widely accepted that the deletion would be considered long overdue. However, we did find it meaningful that Mr Kuroda did offer his view that as the liquidity in the JGB market becomes scarce, the BoJ will need to buy less to control the long-term interest rates. 

The other issue reporters kept coming back to was the exit strategy of the BoJ and if the likelihood of the potential loss in the process could affect its monetary policy and its credibility. Mr Kuroda answered that he feels it is too early and potentially confusing to the market if the BoJ offers its ideas on the exit strategy. As for the potential loss and its implication, he answered that the longer term seigniorage profit will offset the temporary losses.  

Another interesting Q&A, in our view, took place over the ETF purchase. When asked if the purpose of the ETF purchase may already be fulfilled now that the equity market has recovered, he replied that the BoJ is conducting ETF purchase as a monetary policy to achieve its goal. His answer seems to imply that the ETF purchase may go on until 2% inflation target is achieved.
 
Amount of ETFs in Bank of Japan’s balance sheet
 
Note: As of June 10 for June in the chart. 
 
BoJ’s tapering strategy is becoming clearer

While the BoJ prefers not to admit it, it is becoming clearer that the BoJ is intending to reduce the size of its JGB purchase. In our assessment, the pace of reduction could fit somewhere between our “slow taper” scenario and “medium taper scenario”. Under the medium taper scenario, the JGB holding of the BoJ will stabilize around 460-465 trillion yen by mid-2019. With a slower taper, it could continue to rise to 560 trillion yen by 2022. 
 
 
There are a number of ways this tapering strategy could go wrong. The tapering strategy envisaged by the BoJ seems to depend on a stable interest rate environment. But what if global interest rates start to rise, perhaps prompted by a brighter economic outlook in US? In such a scenario, the BoJ will have to be the last buyer of JGBs to keep its 10year rate at the target of 0.0% and when the stampede is over, the scarcity of liquidity in the market could be so crippling that the JGB market could cease to function as a market. In our view, the financial markets in Japan, both equity and debt, are increasingly becoming fragile with their stability entirely depending on the intervention by the BoJ.