Bank of Japan Preview: Balancing Act in the Bond Market
The Bank of Japan is expected to keep rates unchanged with focus on its bond purchasing programme
As the week kicks off, markets are once again preparing for a wave of central bank decisions. Among the most closely watched this week is the Bank of Japan, which is set to meet amidst a backdrop of rising global yields, renewed geopolitical tensions, and stubborn inflation dynamics.
No BOJ hike expected, but bond tapering in focus
Market participants widely anticipate that the BoJ will leave its short-term policy rate unchanged. The focal point instead lies in the potential recalibration of its bond purchasing activity. Reports indicate that the central bank is considering a reduction in its monthly bond purchases from approximately ¥400 billion to ¥200 billion.
This discussion around tapering emerges as long-term yields in Japan come under increasing upward pressure. A recent weak auction for 20-year Japanese Government Bonds (JGBs) drew attention to deteriorating demand conditions in the domestic bond market, raising concerns over liquidity and signalling potential investor unease over the outlook for inflation and fiscal conditions.
Inflation accelerates, supported by negative real rates
Japan's inflation rate has remained above the BoJ’s 2% target for some time, with core inflation accelerating to 3.5% in April. Despite this, the current policy settings still result in negative real interest rates, indicating that monetary conditions remain highly accommodative. This has contributed to growing calls for the BoJ to introduce further policy normalisation, either through tapering bond purchases or signalling a path to higher rates over the medium term.
(Source: Trading Economics)
The BoJ has already begun reducing its balance sheet as part of a broader effort to introduce greater restrictiveness into the policy mix. However, tightening financial conditions too aggressively risks destabilising the domestic bond market, which plays a critical role in Japan’s financial system and serves as a key anchor for global capital markets.
Global implications and capital flow dynamics
The implications of the BoJ’s policy stance extend beyond Japan. For many years, Japan has been a major exporter of capital, with domestic investors allocating funds to overseas markets in search of yield. When domestic yields rise—either due to changing monetary policy or strained bond market liquidity—there is typically a repatriation of capital, which can place upward pressure on global yields and weigh on risk assets abroad.
This shift in global capital flows has already contributed to increased volatility in international bond markets and may continue to influence global equity performance. The direction of travel for the yen is also closely tied to bond market conditions, with tighter Japanese financial conditions generally associated with currency appreciation.
Nikkei and Yen could see heightened volatility
The outcome of this BoJ meeting will largely depend on the scale and scope of any announced tapering measures. A more aggressive-than-expected reduction in bond purchases could lead to further gains in the yen and weigh on Japanese equities, while also reverberating through global bond markets. Conversely, a more measured approach would likely be viewed as supportive of market stability and maintain the BoJ’s cautious stance amid ongoing domestic and global uncertainties.
(Source: Trading View)
(Past performance is not a reliable indicator of future results)
