At a Monetary Policy Meeting held on July 30 and 31, 2024, the Bank of Japan will announce concrete measures for scaling back its government bond purchases. The BOJ’s move to draw down its JGB purchase amount just four months after eliminating its negative interest rate policy in March of this year is faster than initially imagined, but it could be that the yen’s ongoing depreciation led it to push up the timetable.

Additional rate hikes to come no sooner than September?

The Bank of Japan adopted a two-stage approach here, deciding at its June meeting that it would be trimming back its JGB purchases, and is now poised to announce the detailed measures involved at its upcoming July meeting. The reasoning behind this was to listen first to what market participants were saying and only then decide carefully on specific measures, as Governor Ueda explained.
However, the Governor’s statements, for instance that the size of the reduction would be "considerable”, give the impression that the BOJ has already settled on a concrete framework for this scaling back even before soliciting market participants’ views.
One gets the sense that this announcement of detailed measures in July is partly intended to buy time. Buying time, as it were, would mean adopting policy measures in a piecemeal manner to keep constraints on the yen’s depreciation in effect for as long as possible.
At the April meeting, Governor Ueda’s remarks were taken to be permissive toward the weakening yen, at which point the yen continued to depreciate down to 1USD/160JPY. The BOJ, viewing this as a misstep, would now seem to be conducting its monetary policy with a focus on curbing the yen’s ongoing downward slide, which is a factor behind high prices.
If the Bank is aiming to restrain the yen’s decline by making incremental policy adjustments, then it’s possible that at the upcoming meeting in July it won’t make any additional rate hikes to coincide with this drawdown in JGB buying. Further, there’s a risk that enacting two major policy changes at the same time could throw the financial market into chaos, and July would still be somewhat too soon for the data to confirm how far wages will rise following the annual springtime labor negotiations between unions and companies, as well as to know what the spillover effects from wages on prices will be, for example. Given the foregoing, I believe we should expect any additional rate hikes to come in September at the earliest.

Is the BOJ searching for its own style of quantitative tightening?

Given how emphatically Governor Ueda stressed that the scale of the reduction would be “considerable”, the monthly JGB purchase amount of around six trillion yen that was decided on in March could possibly be cut back to around three to four trillion yen.
Since a monthly JGB purchase amount of around six trillion yen roughly matches up with the monthly redemption amount of JGBs held by the Bank of Japan, the outstanding balance of JGBs has stayed nearly the same up to now (Fig. 1). If the purchase amount were to be scaled back to only around three to four trillion yen per month, the Bank’s outstanding JGB balance would clearly begin to drop. This is the beginning of what’s known as quantitative tightening (QT).

When contrasted with the quantitative tightening precedent established by the FRB (US Federal Reserve Board), the quantitative tightening that the Bank of Japan is trying to implement differs in the following three respects, which comes as a surprise (Fig. 2).
First, Governor Ueda made it clear that the Bank’s prime concern was not the scale of the reduction of its JGB balance (i.e., the “stock effect”), but rather the size of its JGB purchases (i.e., the “flow effect”). Now, even if the JGB purchase amount were to be reduced and then maintained at a certain level, since the redemption amount would still fluctuate from day to day, the pace of the balance drawdown would no longer be constant. Since the impact of quantitative tightening on the JGB market would mainly be determined by the changes in the balance of JGBs held by the Bank, it’s questionable whether the flow effect is really an appropriate goal.
Second, the FRB’s policy was to raise short-term interest rates by a certain amount and only then scale down the balance of bonds, i.e., begin quantitative tightening. Yet the Bank of Japan is already set to embark on a course of quantitative tightening while short-term interest rates are still at around 0%.
Third, Governor Ueda stated that the Bank was not working from the assumption that having no excess reserves would be desirable. This means that even after the Bank goes ahead with reducing its JGB buying, it will retain a considerable outstanding balance of JGBs. If the Bank were to keep a significant amount of JGBs on its balance sheet and to maintain its excess reserves, then its quantitative easing policy would persist onward.
These policies might be intended to reduce the risk of a rise in long-term interest rates, but one must wonder why the Bank would shift toward normalizing its monetary policy but choose not to fully normalize quantitative easing (a balance sheet policy). I would like to hear the Bank of Japan explain this point in some detail.

The drawdown in JGB purchases won’t significantly affect long-term interest rates

If the Bank of Japan does begin drawing down its JGB purchases in July as described, what sort of effects will that have on long-term interest rates? While there is some uncertainty, long-term interest rates likely won’t be all that affected.
In 2013, the Bank of Japan began making large-scale purchases of JGBs under a “quantitative and qualitative monetary easing” framework, but this didn’t lead long-term interest rates to fall substantially. This is arguably because at the time that it embarked on that policy, there was already little room left for long-term interest rates to come down.
The Bank of Japan has explained that its JGB purchases drove down long-term interest rates by around1%, but in fact the effect seems to have been smaller than that.
Although the Bank of Japan bought JGBs from banks and in return supplied them with money (current account deposits at the Bank), when interest levels are sufficiently low, even if money is supplied it won’t bring interest rates down and then economic effects won’t materialize. This is what’s called a “liquidity trap”, and it’s possible that the market had already fallen into that very situation.
For this reason, it’s conceivable that even if the Bank conversely cuts back on its JGB buying and reduces the money supply, it won’t lead long-term interest rates to rise by all that much.
I think that in the time ahead, what will have an impact on long-term interest rates and consequently help things reach a stable equilibrium isn’t quantitative tightening, but rather is the extent to which short-term interest rates can be raised.

The increase in short- and long-term interest rates won’t be great, and their economic impact will be limited

The level at which (nominal) short-term interest rates would be neutral in terms of their effect on the economy is determined by the total of the level of “real short-term interest rates”—which have a neutral economic effect and are known as “natural interest rates”—and the level of medium- and long-term inflation rate trends. While it’s difficult to accurately measure the level of natural interest rates, according to the Bank of Japan, multiple estimations indicate that it’s in a range of around +0.5% to -1.0%. Now, let’s assume the level is slightly negative.
In that case, if the medium- and long-term trend in the inflation rate hypothetically were to match the 2% price stability target, then the neutral level of short-term interest rates, and in turn the terminus of their rise, would be slightly under 2%.
Yet in actuality, the recent uptick in prices would seem to be largely attributable to the rise of overseas market conditions and the transient rise in import prices caused by the depreciation of the yen. If we look at the rate of increase in the keynote consumer price index excluding food (except for alcohol) and energy prices, we see that it’s already clearly starting to come down, and the most recent value from May was +1.7% year-on-year, which was below the price stability target of 2%. Ultimately this figure is expected to settle at around the level of 1%. (Fig. 3)
In this scenario, the neutral level for short-term interest rates—and their terminus—would be slightly under 1%, with 10-year JGB yields settling at roughly 1%, which wouldn’t be very much different from where they are currently. (Fig. 4)
Even if the Bank of Japan were to simultaneously raise short-term interest rates and draw down the amount of its JGB purchases, the extent to which short-term interest rates would rise would be relatively small, and as long as long-term interest rate levels also do not change significantly from what they are now, the impact of these policies on the Japanese economy wouldn’t be terribly large either.