Bank of Japan may seek to ease bond market jitters, policy seen on hold

TOKYO Tue May 21, 2013 7:45pm EDT

The Bank of Japan building is pictured in Tokyo, March 29, 2013. REUTERS/Yuya Shino

The Bank of Japan building is pictured in Tokyo, March 29, 2013.

Credit: Reuters/Yuya Shino

TOKYO (Reuters) - The Bank of Japan is expected to stand pat on monetary policy on Wednesday despite jitters over the recent volatility in bond markets, hoping it can prevent a renewed spike in yields by fine-tuning market operations.

The central bank may front-load bond purchases or offer funds via market operations more frequently if bond market turbulence persists, which are technical steps that can be taken by its bureaucrats without approval by the nine-member board.

It is expected to hold off on easing policy through further increases in asset purchases, having already pledged in April to double its bond holdings in two years to expand the supply of money at an annual pace of 60 trillion ($583 billion) to 70 trillion yen.

The monetary policy decision is expected 1130-0100 ET. BOJ Governor Haruhiko Kuroda will hold a press conference from 0630 GMT with his comments expected to come out any time after 0315 ET.

A recent bond selloff, which sent the 10-year yield to a one-year high of 0.92 percent last week, has highlighted the dilemma the central bank faces as it attempts to generate inflation in a country mired in price falls for 15 years.

"The BOJ is walking a very narrow path trying to engineer a gradual, not a sudden, rise in long-term rates backed by improvements in the economy," said an official with knowledge of the central bank's thinking.

The BOJ unleashed the world's most intense burst of stimulus last month, promising to inject $1.4 trillion into the economy in less than two years to meet its pledge of achieving 2 percent inflation in roughly two years.

By gobbling up 70 percent of the bonds newly issued by the government, it hopes to nudge Japanese investors out of the safety of bonds and into riskier assets like equities.

The rise in Tokyo shares to a 5-1/2-year high and improving business sentiment show that Prime Minister Shinzo Abe's expansionary policies have generated more confidence.

BOJ officials say they would accept a natural rise in long-term interest rates that reflect prospects of an economic recovery and future inflation.

But the intensity of the BOJ's purchases caused disruptions in the market by drying up liquidity, which could potentially lead to a damaging sell-off that would be hard to control.

The pace of bond price falls and the huge volatility has made some central bankers nervous but not enough to consider additional policy steps at the two-day policy meeting that ends on Wednesday.

Market players polled by Reuters expect the volatility to ease somewhat, with a median forecast for the 10-year yield of 0.800 percent at the end of this week.

On Tuesday, the yield on the 10-year cash bonds rose 3.5 basis points to 0.880 percent, not far from a one-year high of 0.920 percent last Wednesday.

For now, the central bank hopes to use market operations to stem the volatility. It did so on Wednesday last week by offering to inject 2.8 trillion yen into the Tokyo money market, more than three times the size usually offered in a single day.

If volatility persists, the BOJ may also consider increasing the amount of bonds it buys each month from the current 7.5 trillion yen until bond prices stabilize, sources say.

Japan's economy expanded at an annualized 3.5 percent in the first quarter, the fastest in a year, offering more evidence that Abe's sweeping stimulus is beginning to work.

The BOJ may thus revise up its assessment of the economy to say it is picking up, compared with the previous month's view that it is "bottoming out with some signs of a pick-up."

But a sustained sharp rise in bond yields will hurt corporate capital expenditure, the soft spot of an otherwise more robust economy, and strain Japan's already tattered finances by boosting the cost of funding its huge debt pile.

(Editing by Kim Coghill and Shri Navaratnam)

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