(Bloomberg) -- The Bank of Japan is widely expected to soon conduct its most dramatic policy turn in a decade, but exactly what the aftermath will look like is open to question.

Even as it puts an end to the world’s last negative rate, and concludes its experiment in massive quantitative easing, the bank — it has repeatedly asserted — will keep its policy settings accommodative. That seeming disconnect has prompted economists to speculate over what the new parameters will be.

When the move happens, as most economists expect by April, it will be a complex undertaking.

In addition to lifting its interest rate for the first time since 2007, the bank will have to figure out how it might unwind its balance sheet and at what pace after a decade of world-class QE. The ratio of the BOJ’s balance sheet to the economy is the biggest in the world, with the bank owning about half of the nation’s ¥1,200 trillion ($8 trillion) debt market. It’s also the biggest shareholder in the local equity markets. 

Policy rate

More than 90% of economists expect the new interest rate target to be “around 0%” or “between 0 and 0.1%,” according to a Bloomberg survey conducted last month. That would rule out an initial 25 basis-point moves of the sort favored by the Federal Reserve and European Central Bank.

Deputy Governor Shinichi Uchida gave the clearest hint yet on potential new settings for the short-term interest rate by noting recently how things stood before the subzero rate: The bank applied 0.1% interest to excess reserves and kept the unsecured call rate around 0%.

“If the bank were to bring this situation back, this would mean a 0.1 percentage point interest rate hike, since the current uncollateralized call rate is in the range of minus 0.1 to 0 percent,” Uchida said in a speech on Feb. 8.

Uchida played a prominent role in designing the yield curve control program as well as the scheme for the negative rate. His hypothetical analysis indicates the bank will use the rate on excess reserves as its main policy lever, targeting a range between 0 and 0.1%, whatever nomenclature authorities use to communicate it. That would ensure real interest rates stay in minus territory, highlighting that policy remains easy.

Pace of rate hikes

Uchida caught the attention of BOJ watchers with the reference section of his speech, where he touched on market expectations of the post-hike rate path. A graph reflected expectations for about 50 basis points in increases over two years.

Uchida said with regard to these market views he wouldn’t “endorse or say they’re wrong.” He maintained he was merely pointing them out as a reference.

Some economists weren’t convinced.

“That reference was the biggest message from his speech,” said Masamichi Adachi, chief Japan economist at UBS Securities and a former BOJ official. “The BOJ is endorsing it.”


Governor Kazuo Ueda and his fellow board members have indicated the bank will continue to maintain bond market stability as it did even before the current massive monetary stimulus program kicked off in 2013. However, their remarks have suggested they aren’t wedded to calling the operations YCC. They may just refer to bond buying as they normalize policy.

In shifting guidance, the BOJ could indicate a new ceiling for yields, replacing the current 1% reference for 10-year bond yields. Or authorities could just ditch that and continue to flag an estimated amount of bonds they intend to buy per month. The bottom line is the bank will be giving greater flexibility for market participants to decide yield levels while continuing its intervention when they rise too quickly.

Influencing bond yields has become easier for the central bank as it holds half of the market, a situation that also led to more market functioning side effects. Uchida said the bank hasn’t decided yet on what to do with those holdings.

Risk asset purchase 

As for stocks, Uchida has noted it would be natural to terminate such buying when the bank normalizes policy. That makes it vividly clear that purchases of exchange-traded funds and real estate investment trusts are unlikely to resume on a regular basis without a renewed shock for Japan’s economy or global markets.

After becoming the biggest holder of Japan’s stocks toward the end of 2020, the BOJ has already slowed such purchases markedly. Authorities only bought stock funds three times last year, and it purchased no REITs at all.

What remains open to question is the fate of the bank’s ETF holdings, which were valued at ¥70 trillion this month. Ueda said that the bank has time to consider what to do with these assets, in an indication a precise resolution may not be part of the first steps toward policy normalization.

That suggests the BOJ is in no rush to wind down its balance sheet in the way the Fed and other central banks might do when normalizing policy.

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