July 23, 2018 / 10:51 AM / 5 months ago

Japan starts speculating: Which route of stimulus-reduction will BOJ take?

TOKYO (Reuters) - With markets rife with speculation that the Bank of Japan is close to announcing measures to scale back its massive monetary stimulus, Japanese traders and analysts mused over its options, ranging from subtly changing its policy statement to drastically hiking its bond yield target.

FILE PHOTO: Men work on the outside of the Bank of Japan building in Tokyo, Japan January 15, 2018. REUTERS/Kim Kyung-Hoon

Sources told Reuters on Friday that the BOJ is in unusually active discussions ahead of a policy decision at the end of July, with changes to its interest-rate targets and stock-buying techniques up for debate.

While the Japanese bond market on Monday posted one of the largest falls since the BOJ started the currency policy in September 2016, many market players remained skeptical of the prospects of the BOJ making policy changes at the upcoming policy review on July 30-31.

“Compared to when the BOJ decided to do a comprehensive policy review in July 2016, you cannot avoid the impression that there is no clear conclusion yet in the BOJ on what it wants to do,” said Chotaro Morita, chief rates strategist at SMBC Nikko Securities.

Many market players think, rather than making a policy change this month, the BOJ’s board is likely to instruct its staff to study measures to alleviate the “side effects” of the prolonged easing, i.e. damage to interest earners such as banks.

Analysts say the BOJ could weigh several options.

DROPPING QUANTITATIVE TARGET

The BOJ could drop its reference - in every policy statement since September 2016 - that it aims to increase its government bond holdings by 80 trillion yen ($719.75 billion) a year. However, reflationist board members are likely to oppose this step.

Dropping the statement might only have limited economic impact, because the BOJ has already slowed the pace substantially, to around 40 trillion yen per year.

RAISING 10-YEAR YIELD TARGET

Many investors have expected the BOJ’s next policy step to be a hike in the 10-year yield target from the current zero percent to around 0.10 percent or 0.25 percent.

While that would please investors such as insurers and pension funds, analysts say the BOJ will have a hard time justifying lifting the target when it is likely to cut its inflation forecast.

CHANGING YIELD CURVE TARGET

The BOJ could set a zero percent target in the five-year JGB yield instead of the current the 10-year yield. That would steepen the yield curve and would allow the curve to move more freely than now.

By maintaining the nominal zero percent target, the BOJ could give the impression it is not tightening policy very much.

ENDING NEGATIVE INTEREST RATES

Ending negative short-term interest rates would work best in terms of reducing the pain of banks. But few think it as a viable option as long as inflation stays low.

MAKING BOND OPERATIONS FLEXIBLE

While maintaining the zero percent target, the BOJ could allow the 10-year yield to move more freely. Until now, the BOJ has effectively capped the 10-year yield at 0.11 percent, by offering an unlimited amount of buying at that level.

MAKING ETF PURCHASES MORE FLEXIBLE

The BOJ could loosen its commitment to buy 6 trillion yen of stock ETFs annually, but many think such a proposal would face a high political hurdle.

Such a measure likely would have to wait at least until September, when Prime Minister Shinzo Abe, a strong advocate of easing, will face a ruling party leadership contest.

Editing by Richard Borsuk

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