The Bank of Japan (BOJ) recently announced its decision to keep interest rates unchanged and slow the pace of its government bond purchases, a move aimed at preventing abnormal volatility in the government bond market amidst global trade uncertainties. This decision follows years of ultra-loose monetary policy, during which the central bank heavily purchased Japanese Government Bonds (JGBs) to maintain low yields, combat stagnation, and overcome deflation.

The BOJ began shifting away from this aggressive easing program last year, as inflation started to pick up and the yen weakened. After the first interest rate hike since 2007, the bank gradually started winding down its JGB purchases and has since lifted borrowing costs several times to 0.5 percent, marking their highest level in 17 years. Despite these moves towards policy normalization, analysts suggested that ongoing trade tensions, particularly those sparked by US President Donald Trump’s policies, had influenced the bank to hold off on further rate hikes.

During its two-day policy meeting, the BOJ reiterated its commitment to maintaining short-term rates at around 0.5 percent. BOJ Governor Kazuo Ueda emphasized the importance of a predictable reduction in JGB purchases while ensuring flexibility to support market stability. He stated, "This measure was taken in order to avoid the possibility of an abnormal volatility in government bond yields, which would have a negative impact on the economy." He added, "We believe that it is appropriate for the Bank of Japan to reduce its JGB purchases in a predictable manner, while ensuring flexibility."

Specifically, the bank's policy statement outlined that bond purchases would be cut "by about 200 billion yen each calendar quarter from April-June 2026." This represents a slower reduction compared to the current plan of cutting approximately 400 billion yen (equivalent to about $2.8 billion) per quarter. The goal is to allow long-term interest rates to form naturally in financial markets, without causing sudden disruptions. Governor Ueda explained that a too-rapid pace of reduction could have an unexpected effect on market stability, and the decision reflects a careful balance between these considerations and market participants' opinions.

While the BOJ's main rate remains significantly lower than the US Federal Reserve's 4.25-4.5 percent, the central bank anticipates a moderation in Japan’s economic growth. This slowdown is attributed to the impact of trade and other policies on overseas economies, potentially leading to a decline in domestic corporate profits. However, accommodative financial conditions are expected to provide some support. Katsutoshi Inadome of SuMi TRUST still believes the BOJ might hike rates in the latter half of the year, maintaining its commitment to monetary policy normalization. Conversely, Carol Kong of the Commonwealth Bank of Australia suggested the BOJ would likely wait for further clarity on US trade policy before considering additional rate hikes, noting that despite solid wage growth and consumer price inflation, there are questions about domestic demand’s ability to withstand further tightening.

The JGB market has experienced recent volatility, driven by concerns over Japan's fiscal health, which at times caused bond prices to fall and long-term yields to rise sharply. The BOJ's latest measures are designed to improve JGB market functions and provide stability, ensuring a smooth and orderly adjustment to its monetary policy framework.