Financial market disorder has the potential to influence how quickly the Bank of Japan moves to shrink its vast portfolio of government bonds, according to people familiar with the central bank’s deliberations. With long-term yields climbing and showing strains tied to fiscal and inflation dynamics, BOJ officials are weighing whether to temper the pace of quantitative tightening (QT) to avoid intensifying market stress.
Those people - three sources who spoke on condition of anonymity because they were not authorised to comment publicly - stressed that the BOJ maintains a high threshold for intervening directly in the bond market. Still, they said the central bank could indicate a slowdown or even a temporary pause in its unwind of holdings for the next fiscal year if market conditions warrant such an adjustment.
Under Governor Kazuo Ueda, the BOJ began rolling back part of its large-scale bond purchases in 2024 as a step toward normalising monetary policy after decades of extremely low interest rates. The bank’s holdings have been trimmed and now sit at around 500 trillion yen ($3.14 trillion). While a rate increase is broadly expected at the June 15-16 policy meeting to address elevated inflation, the BOJ may signal a more cautious approach to tapering its bond-buying amid growing uncertainty outside Japan.
The sources emphasised that no final decision has been reached on the precise tempo of tapering. They said the BOJ sees little justification for rushing reductions to its sizeable balance sheet while markets are fragile.
"The BOJ’s bond holdings have decreased quite a bit, so there could be a case to pause its taper to provide sufficient liquidity," one of the sources said, noting the potential role of a pause in calming market pressures. A second source added that a slowdown or temporary halt in tapering cannot be ruled out, particularly if jittery market conditions persist. A third source repeated a similar view.
The BOJ will examine its current taper blueprint, which runs through March of the coming year, and will present a new plan for fiscal 2027 at the June policy meeting. In preparation, the bank has gathered feedback from bond investors and scheduled two-day meetings with market participants beginning Thursday to take stock of preferences on the speed of bond purchase reductions. Officials say the input collected will heavily influence the final shape of the taper plan.
For policymakers, the upcoming decision will test Governor Ueda’s determination to methodically withdraw a decade-long era of extraordinary stimulus that was rolled back starting in 2024. Sources said the BOJ is likely to adhere to the taper schedule through March next year for now and does not currently see a need to initiate emergency bond-buying operations - a contingency tool reserved for "rapid rises in long-term interest rates." They added that there is limited reason to intervene when rising yields reflect fundamental assessments by investors of fiscal and monetary policy, since such moves indicate market functioning.
Analysts caution that direct market intervention presents risks. Any large-scale purchases to cap yields could force the BOJ to repeatedly defend a chosen rate level, potentially becoming costly and exposing the bank to accusations of debt monetisation. "It’s a risky step that could backfire if markets perceive it as debt monetisation," said Katsutoshi Inadome, senior bond strategist at Sumitomo Mitsui Trust Asset Management. He added that he does not believe the BOJ is currently at the point of intervening in the market.
How the BOJ’s options look to markets
Market watchers have narrowed the range of plausible responses the BOJ could adopt for fiscal 2027. Under the QT programme that began in 2024, the BOJ has been tapering monthly bond purchases and, at present, reduces its monthly buying by roughly 200 billion yen each quarter. The current buying pace is about 2 trillion yen per month.
Observers typically outline three paths:
- Pause the taper and continue purchasing at the existing rate of around 2 trillion yen per month, which would send a more soothing signal to jittery markets.
- Maintain the present glidepath and continue trimming monthly purchases by 200 billion yen each quarter, signalling a steady and ongoing QT programme.
- Pursue an intermediate adjustment by slowing the reduction pace to 100 billion yen per quarter as a compromise between policy normalisation and market stability.
Views differ among strategists. Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, said she expects the BOJ to opt for a pause in tapering given the instability in the bond market. Inadome, meanwhile, judged that there is a good chance the BOJ will instead choose the middle option and scale back the taper to 100 billion yen per quarter.
The BOJ has also stated that its QT programme is separate from its approach to short-term interest rates, which remain the primary instrument of monetary policy. Nevertheless, officials may be wary of conveying the impression of tightening financial conditions twice over - by raising short-term rates in June while simultaneously accelerating the supply of JGBs through a faster taper. As a result, they may elect to slow or pause the QT process if they raise short-term rates to avoid compounding pressures on funding markets.
Structural sensitivities and warnings
Policymakers and international observers have flagged structural changes in the Japanese bond market that heighten sensitivity to BOJ moves. The Organization for Economic Co-operation and Development warned about risks stemming from a lower proportion of JGBs held by banks, insurance companies and pension funds after many years of low interest rates. Annual runoffs of maturing JGBs have already driven the BOJ’s holdings down by nearly 20% from a peak around 590 trillion yen in late 2023.
Despite that decline, the BOJ still owns roughly 49% of all outstanding JGBs, giving its policy choices material sway over yields and the cost of servicing Japan’s large public debt. This concentration underscores why decisions on tapering can reverberate widely across markets and funding conditions.
Even among more hawkish members of the BOJ, concern about market fragility has been voiced. Board member Hajime Takata warned of the risks of undermining market functioning if reductions in purchases flood the market with JGBs and induce excessive volatility. In February he emphasised the need to avoid causing disorder that could impair the JGB market’s functioning.
Bottom line
The BOJ is preparing to raise short-term policy rates at its mid-June meeting but faces a delicate judgement on how quickly to continue trimming a balance sheet that remains among the largest in global terms. Officials appear prepared to slow or pause the tapering process if bond-market turmoil persists, while retaining emergency operations as a contingency. The June policy meeting will be the forum for reviewing the taper path through March next year and for setting the course into fiscal 2027, with input from bond investors playing a central role in shaping the final decision.
($1 = 159.0300 yen)