Bank Of Japan Said To Start Preparing For Losses On Its “Huge” Debt Holdings Once QE Ends

While it most likely is just the usual Friday (past) midnight trial balloon by the Nikkei, a media outlet that has promptly become the BOJ’s mouthpiece (recall a week ago the new owner of the FT reported that Abe would delay his 2017 sales tax increase, only to see the premier backpedal when the reaction in the USDJPY was not quite as desired), the Japanese publication reported that the Bank of Japan will “likely set aside funds for the first time to prepare for losses on its huge holdings of Japanese government bonds should the central bank end its monetary easing policy in the future.”

Nikkei reports that the BOJ has reserved 450 billion yen ($4.07 billion) for the year ended in March. The amount will become known when the BOJ releases financial statements as early as next week. The way the BOJ is preparing for losses is amusing: it is accruing the interest income from the bonds it owns so it can reserve for capital losses on those same bonds once rates spike, to wit:

The BOJ created a framework last fiscal year that permits it to set aside part of the interest income from its JGB holdings, which have ballooned through the bank’s massive monetary easing program. Interest income likely grew about 30% from the prior year to around 1.3 trillion yen in fiscal 2015.

Though BOJ Gov. Haruhiko Kuroda has indicated that the bank could expand easing if it faces difficulty achieving its inflation target, the creation of the reserves is a move to prepare for an exit from monetary easing.

The central bank’s JGB holdings totaled 349 trillion yen as of March 31, up about 180% in three years. Long-term interest rates, currently in negative territory, will rise and bond prices will fall should the BOJ end its monetary easing once it is sure that Japan is finally breaking free of deflation.

According to Nikkei, the bank estimates that a 1 percentage-point rise in long-term rates lowers the value of its JGB holdings by 21 trillion yen, or about $200 billion, which incidentally is about 50x more than the BOJ is said to be reserving, which implies that the BOJ is expect only a tiny increase in rates.