BOJ tolerates yield rise, may trim super-long bond buying further

By Leika Kihara

TOKYO (Reuters) – The Bank of Japan is following through on its pledge in July to allow bond yields to move more flexibly, refraining from intervening in the market on Thursday even as long-term interest rates tracked U.S. Treasury yields to hit multi-year highs.

With its huge bond buying draining liquidity, the central bank is seen tolerating further rises in super-long yields as long as the increase does not push 10-year yields well above its zero percent target, say sources familiar with its thinking.

That means the BOJ could continue to slow purchases of super-long bonds, as it had done in late September, once markets stabilize and there is no big risk that such tapering would trigger an unwelcome spike in 10-year yields, they say.

“There’s room to allow super-long yields to rise more, as long as 10-year rates stay around the BOJ’s target,” one source said on condition of anonymity, a view echoed by two other sources.

Under its yield curve control (YCC) policy, the BOJ pledges to guide short-term rates at minus 0.1 percent and the 10-year government bond yield around zero percent.

Responding to criticism its huge buying was draining market liquidity, the BOJ decided in July to allow yields to make bigger moves around its zero percent target. But long-term rates continued to hug a tight range on expectations the BOJ would keep policy ultra-loose for a prolonged period.

A spike in U.S. Treasury yields, however, changed the mood and drove up 10-year Japanese bond yields by 2 basis points to 0.155 percent, the highest level since the BOJ adopted negative interest rates in January 2016. Super-long yields also rose with 30- and 40-year yields hitting levels not seen since 2016.

And yet, the BOJ refrained from stepping in on Thursday unlike on Aug. 2, when it conducted an unscheduled bond buying operation to prevent long-term rates from rising further.

The decision likely reflected the fact that Japanese yields were grinding up in line with higher overseas yields, rather than jumping abruptly on speculative trading, the sources said.

It also underscored the hope of BOJ policymakers, mindful of the demerits of prolonged easing, to breath life back to a bond market that saw trading shrink due to the bank’s huge purchases.

While the BOJ would not intentionally try to boost market volatility, it would be comfortable letting super-long yields rise more freely, they said.

Market expectations the BOJ will speed up its tapering of bond purchases heightened after the central bank trimmed buying of super-long bonds late September.

Some investors also took a cue from an academic paper the BOJ issued on Oct. 1, which signaled the bank’s huge balance of debt holdings alone had a big impact in keeping yields low.

“Super-long yields aren’t the BOJ’s policy target, so the BOJ could trim bond buying for these maturities,” said Izuru Kato, chief economist at Totan Research.

“The BOJ probably doesn’t want to buy too much super-long bonds, because they would remain in the BOJ’s balance sheet for a very long time.”

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