BOJ keeps rates steady, slows bond taper, what it means for Japan’s economy?

The Bank of Japan (BOJ) is pressing pause on the pace of its balance sheet drawdown, signalling a cautious turn in its policy normalisation journey amid rising global uncertainty.

On Tuesday, the central bank held interest rates steady at 0.5 per cent, its highest level since 2007, but announced that it would reduce its purchases of Japanese Government Bonds (JGBs) at a slower pace beginning next year, as reported by Reuters.

What exactly did the BOJ decide?

Since ending its yield curve control and negative interest rate policy, the BOJ has been gradually scaling back its massive JGB holdings in a bid to exit its decade-long ultra-loose monetary regime. Under the previous plan, the bank was reducing bond purchases by around 400 billion yen (approximately $2.8 billion) per quarter.

Now, starting April 2026, the pace will be halved to 200 billion yen per quarter, effectively delaying the target of tapering bond purchases to 2 trillion yen per month until March 2027, as quoted by Reuters.

The move marks a significant shift in tone, especially as inflation in Japan remains above the BOJ’s 2 per cent target. Consumer prices rose 3.5 per cent year-on-year in April, driven by surging food costs and sustained wage pressures, Reuters reported.

Why slow down now?

Two words: global risk.

The BOJ’s revised taper plan comes as storm clouds gather over the global economy. An escalating Iran–Israel conflict has triggered fears of energy price shocks, while fresh US trade tariffs on Japanese goods — imposed under President Donald Trump’s new “reciprocal” policy, threaten to derail Japan’s export recovery.

In a statement, the BOJ said it would act “nimbly” if long-term interest rates spiked, hinting at readiness to buy more bonds again if market volatility resurfaces, as per Reuters.

As Lee Hardman of MUFG noted before the meeting, “The recent softening of the yen could already partly reflect expectations for a cautious policy update from the BOJ… alongside negative spillovers for Japan from the Middle East conflict,” as quoted by Reuters.

Bond market turmoil prompts caution

The BOJ’s decision follows weeks of volatility in the JGB market. Last month, a weak auction of 20-year bonds sent yields soaring across maturities, with the 40-year JGB yield hitting a record 3.675 per cent. Demand from traditional buyers like insurers has waned, adding to market instability, according to Reuters.

With Japan’s debt burden standing at a staggering 250 per cent of GDP, the highest in the developed world — any spike in yields poses significant fiscal risks. Finance Minister Katsunobu Kato warned that higher borrowing costs “could further imperil Japan’s finances,” as per Reuters.

To calm nerves, the finance ministry is reportedly planning to cut issuance of super-long bonds and may even launch buybacks to contain borrowing costs, Reuters has reported.

Domestic pressure vs external shocks

While Japan’s economy is seeing inflation, the BOJ is walking a tightrope. On the one hand, persistent cost pressures and labour shortages are prompting firms to raise wages, a potential sign of sustainable inflation.

But on the other hand, sluggish exports, Trump’s tariff threats, and war-driven oil volatility threaten to choke off growth. Prime Minister Shigeru Ishiba has admitted that trade talks with the US have not produced a breakthrough, as quoted by Reuters.

Carol Kong of the Commonwealth Bank of Australia told AFP that “slowing the bond taper will help keep interest rates lower than otherwise, providing support to the economy amid heightened trade uncertainty.”

What’s next?

The BOJ said it will conduct an interim review of its fiscal 2026 taper strategy at its policy meeting in June next year. Analysts believe the bank could resume rate hikes later in 2025, if inflation remains sticky and economic growth holds.

But until then, the message from Tokyo is clear: caution first.

As the world’s third-largest economy battles both internal and external headwinds, the BOJ is in no rush to tighten the screws, especially with a volatile bond market and geopolitical turmoil at its doorstep.

(With inputs from the agencies)