The Bank of Japan (BoJ) is scheduled to hold a monetary policy meeting from June 15 to 16. Market expectations for a rate hike continue to build, while scrutiny over its bond-buying program intensifies. Due to heightened volatility in the bond market, many investors believe the BoJ should pause its tapering of bond purchases in the next fiscal year. Such a pause would mark a turning point in the central bank's quantitative tightening (QT) policy, which has been in place since 2024 as part of Governor Kazuo Ueda's efforts to exit a decade-long era of massive monetary easing.

At the upcoming meeting, the BoJ is expected to review its tapering plan through March of next year and formulate a new schedule for fiscal year 2027. The market widely anticipates no changes to the existing tapering schedule, shifting focus to the next fiscal year: whether the BoJ will continue reducing its monthly bond purchases in FY2027 or maintain the current pace.

According to two informed sources, while no final decision has been made internally at the BoJ, the persistent turbulence in the bond market—partly due to uncertainties surrounding Iran—has made a pause in tapering an increasingly preferred option. One source commented on the tapering plan, stating, "The market remains volatile; there's no need to rush." The source added that most market participants also favor maintaining the current purchase scale.

Political considerations are also pushing the BoJ toward a pause. Rising Japanese government bond (JGB) yields are increasingly constraining the spending plans of the Sanae Takaichi administration. "The last thing the Japanese government wants is for bond yields to rise," the source noted.

Calls for a pause in tapering are growing. A BoJ survey shows some investors are already urging the central bank to halt the reduction, highlighting the practical challenges the BoJ faces in reducing its massive JGB holdings. There have been prior indications that, given market uncertainties, the BoJ might consider slowing its tapering schedule.

The BoJ will release minutes from its meetings with bond market participants held on May 21-22 next week, which should provide further clarity on the tapering plan's direction.

Former BoJ official Nobuyuki Atago remarked, "We have seen a significant rise in bond yields, making it difficult for investors to purchase bonds. The Ministry of Finance may also be starting to worry." He added, "Given the current political headwinds, I see no reason for the BoJ to continue tapering in the next fiscal year."

Former BoJ board member Makoto Sakurai stated on Friday that, considering recent bond market volatility and the progress made in reducing the balance sheet, the tapering could potentially be stopped next year.

Last week, the yield on the 10-year JGB surged to 2.8%, a 30-year high, driven by market concerns over Japan's deteriorating fiscal health and rising inflation. This level is close to the 3% assumption used by the Ministry of Finance in drafting the budget for FY2026. Yields exceeding 3% would increase debt servicing costs and reduce fiscal space for other expenditures.

The BoJ's decision on interest rates may also influence its tapering plan. The market widely expects the BoJ to raise its benchmark policy rate from 0.75% to 1.0% at the June meeting. Analysts note that while the BoJ has stated its tapering plan is independent of monetary policy direction, a rate hike in June would provide stronger justification for slowing the pace of tapering.

Nomura Securities interest rate strategist Mari Iwashita commented, "Given the bond market's instability, the BoJ is likely to proceed cautiously to avoid triggering unnecessary market turmoil." She expects the BoJ to pause its tapering in FY2027. "Combining a tapering pause with a rate hike would be a good strategy," she said, explaining that the former would ease upward pressure on yields while the latter would alleviate concerns about falling behind the curve.

The political resistance highlights a broader challenge. For years, major central banks have expanded their balance sheets through massive bond purchases to stimulate their economies. Now, with rising debt levels and increased yield volatility, they face significant hurdles in unwinding these positions. In the United States, as the appeal of U.S. Treasuries wanes, industry observers question whether new Federal Reserve Chair Kevin Warsh can advance QT plans.

The BoJ has also proceeded cautiously since initiating QT in 2024, adopting a gradual tapering approach that currently reduces monthly purchases by 200 billion yen per quarter. Political resistance to QT has intensified against the backdrop of the Takaichi administration's policies favoring tax cuts and increased spending, funded by bond issuance.

Even if the BoJ does not continue its step-by-step reduction, its JGB holdings, amounting to approximately 500 trillion yen, will still decline steadily as bonds mature. This process has already reduced the size of its balance sheet by 20% from its peak at the end of 2023.

Akira Otani, Managing Director at Goldman Sachs Japan and former senior economist at the BoJ, argues that given these circumstances, the BoJ should maintain its current purchase pace. He pointed out, "Inflation risks from the Middle East situation, combined with the Japanese government's proactive fiscal policy, are pushing bond yields higher. Further tapering could drive yields up even more, potentially sparking political friction."