Fasten your seat belts! Will the Bank of Japan take the "first step" towards tightening tomorrow?

In contrast to the global trend of central banks cutting interest rates, the Bank of Japan is moving towards monetary tightening.

Although the Bank of Japan ended the era of negative interest rates in March, it seems that there is a lack of actual tightening despite the name, and the market impact is limited, with the Japanese yen continuing to weaken.

The Bank of Japan may take the first step towards tightening at the June policy meeting. Around 11 a.m. Beijing time on Friday, the Bank of Japan will announce its interest rate decision, followed by Governor Haruhiko Kuroda holding a monetary policy press conference at 14:30 in the afternoon.

The market generally expects that the overnight unsecured call rate will remain unchanged at 0-0.1%. The focus of this week's policy lies in:

• The Bank of Japan may reduce the scale of bond purchases, possibly through policy statements or Governor Kuroda's press conference. Most forecasts suggest that the reduction in scale will not exceed 1 trillion yen. If the reduction exceeds this scale immediately, it may cause volatility in the yen and bond yields.
• Governor Kuroda's views on recent economic data and thoughts on the conditions and timing of future rate hikes, paying attention to whether signals for a rate hike next month are released.

Furthermore, the policy statement at the April meeting was very simple, only stating the policy rate guidance and asset purchase guidance, i.e., "The Bank of Japan will make purchases based on the decision of the March 2024 monetary policy meeting." In the next policy statement, analysts believe that the statement may include expressions of policy guidance, such as "If the current outlook for economic activity and prices is realized, and underlying inflation increases, the Bank of Japan will adjust the degree of monetary easing."

Point One: Bank of Japan Expected to Consider Reducing Bond Purchases

Since ending negative interest rates in March and embarking on the path of policy normalization, reducing bond purchases will be the Bank of Japan's first step towards quantitative tightening. With expectations of a Fed rate cut this week and stable Japanese government bond yields, this is a good time for the Bank of Japan to discuss bond purchases.

Among economists surveyed by the media, more than half believe that the Bank of Japan will slow down the pace of bond purchases, with the current target amount for monthly bond purchases at around 6 trillion yen. If the purchase amount is significantly lower than 6 trillion yen, it indicates that quantitative tightening is underway.

Regarding the details of reducing bond purchases, analysts generally believe that the Bank of Japan is unlikely to significantly reduce them immediately, but rather make minor adjustments.

Morgan Stanley stated:

We expect the Bank to provide guidance or a blueprint for reducing its monthly bond purchase amount in the future. We believe that there will be no immediate reduction in purchases before the rate hike in July. If a decision is made to reduce the purchase amount this month, we believe it will be a slight reduction to around 5 trillion yen per month.

Point Two: Will Signals for a July Rate Hike Be Released?

In addition to the increasing expectations of reduced bond purchases, the expectation of a rate hike in July by the Bank of Japan has been growing due to the continued weakening of the yen.

According to a media survey, one-third of economists surveyed expect a rate hike next month, while about 60% believe there is a possibility. Pay close attention to Governor Kuroda's remarks on the future policy path during the press conference. Bank of America Merrill Lynch expects that the Bank of Japan will raise its policy interest rate to 0.25% at the July meeting. Morgan Stanley also holds a similar view:

Considering the recent speeches by Governor Kuroda and Deputy Governor Amamiya, we believe that the Bank of Japan's confidence in the transmission of wage increases to small and medium-sized enterprises has strengthened. We expect that after the release of the relevant surveys on July 3rd and July 8th, the Bank will slightly raise the policy interest rate from 0.1% to 0.25% at the July monetary policy meeting.

UBS believes:

Importantly, Governor Kuroda and other board members have indicated that if the depreciation of the yen affects underlying inflation, the Bank of Japan will respond. However, given that Japan's core CPI has cooled for two consecutive months, we expect the Bank of Japan to make such a judgment at the next meeting.

Our baseline expectation is that the Bank of Japan will raise the policy interest rate from the current 0-0.1% to 0.25% on October 31st, contingent on the confirmation of actual consumption and service inflation in economic data rebounding.

Focus Three: How will the yen and Japanese bonds perform?

If the Bank of Japan's final actions deviate from expectations, it may trigger volatility in the yen and Japanese bonds.

The yen has depreciated by over 10% against the US dollar year-to-date, making it one of the worst-performing major currencies. Faced with the dilemma of a weak yen, if the Bank of Japan does not provide any hints of tapering bond purchases after the meeting, it may further weaken the yen.

Analysis suggests that if the Bank of Japan does not change its policy at all, yen depreciation may accelerate, similar to the rapid decline in the yen in April when the Bank of Japan took no action.

On the US bond side, according to the Bloomberg Global Bond Index, Japanese government bonds have fallen by about 3% this year, making them the worst-performing bonds in the Asian region.

Bank of America Merrill Lynch's expectation: