UBS - BoJ's roadmap for gradual QT and deferred rate hike

The Bank of Japan (BoJ) indicated its plan last week to maintain current policy settings and initiate a gradual process of quantitative tightening (QT).

The bank's QT strategy, which involves reducing bond purchases, is expected to commence following a reduction plan to be formulated at the July meeting.

UBS analysts predict the BoJ's QT will result in a reduction in bond purchases by approximately JPY 2 trillion per month. This reduction could lead to a 3-5% decrease in the BoJ's government bonds over the next year.

However, the recovery in demand has been slower than anticipated, prompting UBS to revise its forecast for the next rate hike from July to October. Even with this adjustment, market predictions still indicate a 30% chance of a July rate hike.

In their June meeting, the BoJ maintained the target for short-term interest rates and the uncollateralized call rate at 0.0-0.1%. The bank also indicated it would decide on a specific reduction plan for the next 1-2 years at the July meeting and then initiate QT.

UBS analysts believe the BoJ's gradual approach to QT is primarily a safeguard against sudden interest rate fluctuations. If the BoJ adopts more aggressive measures such as reducing bond purchases by half or completing QT within two years, there could be a risk of significant market volatility and a broader scope for interest rate increases.

The UBS report further discusses the implications for the foreign exchange market and Japanese equities. It suggests that with the BoJ's decision to delay tapering its JGB purchases till July, USDJPY is likely to remain at elevated levels in the near term.

However, the upside risks for the pairing could be mitigated considering BoJ Governor Ueda's comments about a substantial reduction in JGB purchases.

The analysts also discuss the implications for Japanese equities, mentioning the positive impact of inflation, wage growth, and corporate governance reforms. These factors, along with the shift in BoJ Governor Ueda’s tone against yen weakness, have heightened market awareness, leading to a likely delay in policy rate hikes.