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(Bloomberg) -- The Bank of Japan made a significant step toward shrinking its massive balance sheet last week, while market watchers were fixated on the biggest interest rate increase from the central bank in 18 years.
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The BOJ decided on Friday to offer no new lending from July under its fund-provisioning program to stimulate bank lending. The program’s outstanding loans stood at ¥77 trillion ($496 billion) as of Jan. 20, accounting for around 10.4% of the central bank’s overall balance sheet, according to BOJ data.
The phasing out of the loan program underscores BOJ Governor Kazuo Ueda’s determination to slowly but steadily proceed with the normalization of policy after more than a decade of radical monetary easing.
All the outstanding loans are now set to expire in early 2028. January also marks the final month for the purchase of commercial paper and corporate bonds, a move first flagged last March. That’s another 6.5 trillion yen that will disappear from the balance sheet by January 2028.
Together with last year’s decision to cut the purchase of government bonds, the central bank has now secured ways to trim its enormous balance sheet by more than 15% as it proceeds with quantitative tightening.
“Although it got little attention, ending the funding program is a big decision,” Kentaro Koyama, chief Japan economist at Deutsche Securities, said in a Bloomberg survey this week.
The need to undergo quantitative tightening is not unique to the BOJ. Many of the bank’s global peers have already been trimming balance sheets that became bloated during the pandemic as priorities changed from supporting the economy to battling inflation. But the relative scale of the BOJ’s holdings, at 126% against the size of the economy, towers above that of the Federal Reserve or the European Central Bank at closer to 30% of gross domestic product.
Still, the Fed’s experience points to potential risks ahead for the BOJ as it tries to reduce its balance sheet without spooking markets.
The Fed started tightening in 2022, but in June last year policymakers were forced to slow the pace of unwinding, amid growing concerns over the asset runoff roiling short-term funding markets.
After the stand-pat decision on Wednesday, Chair Jerome Powell reiterated the Fed’s readiness to adjust the details of its balance sheet reduction approach if needed to ensure the smooth transition of monetary policy in light of economic and financial developments.