MNI POLICY: BOJ Mindful Of Overreaction To JGB Stock-Effect

The Bank of Japan remains concerned about renewed volatility in the JGB market as it continues to shrink its bond portfolio, wary of a potential overreaction from market participants who have yet to price in the pace of the reduction fully – an outcome that could force the central bank to intervene again, MNI understands.

While the BOJ board this month decided to slow the pace of its bond purchase reductions to JPY200 billion per quarter from April 2026 to March 2027 from the current pace of JPY400 billion, in part to avoid further bond-market volatility, the Bank projects that its holdings will decline by 16-17% by March 2027 from June 2024 levels – compared with an estimated 7-8% drop by March 2026 – mainly driven by redemptions. (See MNI BOJ WATCH: Ueda Flags Gradual Hikes, Warns Of JGB Risks)

The board's taper decision reflects concerns that market participants have not priced in a more substantial decline in its bond holdings.

Any market overreaction driven by this falling stock effect – which bank officials see occurring gradually – could exert upward pressure on long-term yields, potentially weakening economic fundamentals. While the BOJ generally allows market forces to guide JGB yield formation, a sustained rise could prompt it to step in with extraordinary bond-purchase operations, which the bank wants to avoid as any action would likely draw renewed market focus and heighten sensitivity to its moves.

JGB IMPACT

The BOJ’s own quantitative analysis from March 2021 showed its JGB purchases had a statistically significant effect in lowering long-term interest rates by roughly one percentage point on average.

As of December 2024, the BOJ held around JPY560 trillion in JGBs, equivalent to about 52% of the total amount outstanding. The Bank is scheduled to purchase JPY42 trillion in JGBs in the current fiscal year and JPY29 trillion in fiscal 2026, against projected redemptions of approximately JPY80 trillion and JPY72 trillion.

While BOJ officials acknowledge that the scale of their bond holdings remains substantial, they stress that a gradual reduction is the only feasible approach, as a rapid unwinding could trigger disorderly yield spikes.

Officials have also not settled on a target level for the current account balance, which stood at JPY528 trillion as of June 19. While the theoretical benchmark is the combined total of banknotes in circulation – around JPY120 trillion – and circa JPY12 trillion required reserves, officials think it is premature to define a goal given the uncertainty around commercial banks’ appetite for excess reserves. The current balance remains far above such an appropriate level.