MNI POLICY: BOJ Sees Bond Sell-Off As Reflecting Market

The Bank of Japan considers that the recent sell off in government bonds reflects proper market functioning, given concerns over Japan’s fiscal situation and U.S. inflation risks, though it remains prepared to conduct an extraordinary purchase operation should yields spike too fast.

While the BOJ can make extraordinary purchases if JGB yields spike, officials are wary of being seen to support government financing. They are also aware that the fundamental drivers of higher yields would persist after any such operation, and that foreign investors in particular would pressure for further purchases by selling their holdings.

Inflation above the BOJ’s 2% target also reduces the motivation for purchases.

REDUCING BALANCE SHEET

Whilst officials point to no specific yield as of particular concern, insisting that they are more focussed on the speed of any potential move and signs of unhealthy speculation, market players see 2% as a key level.

The 10-year JGB yield rose to 1.595% on Tuesday, the highest since October 2008 amid concern over potential government spending related to July’s upper house elections and yields on longer-end JGBs also rose. The 10-year yield fell to 1.570% in late trade on Wednesday.

The BOJ is attempting to steadily reduce the size of its balance sheet. It is set to buy a total of JPY42 trillion in bonds this fiscal year, well below redemptions of JPY80 trillion, while in fiscal 2026 it will reduce its purchases to JPY29 trillion in fiscal 2026 versus redemptions of JPY72 trillion, meaning that market players need to absorb JGBs worth of JPY82 trillion. (See MNI POLICY: BOJ Mindful Of Overreaction To JGB Stock-Effect)