(Bloomberg) -- The Bank of Japan is widely expected to consider reducing its bond purchases at this week’s policy meeting, with investors also alert for any signals on the prospects for an interest rate hike next month.

Governor Kazuo Ueda’s policy board will hold its benchmark rate in a range between 0 and 0.1% at the Friday conclusion of its two-day gathering, according to all but one economist surveyed by Bloomberg. More than a half said the bank will slow the pace of bond buying from roughly ¥6 trillion ($38.2 billion) per month.

The BOJ will probably mull whether it’s appropriate to reduce bond buying and to improve predictability of those operations, people familiar with the matter told Bloomberg. A trimming of the purchases would be the BOJ’s first clear step toward quantitative tightening after it embarked on the policy normalization path by ending its massive stimulus program in March.

The yen rose in response to weaker-than-expected inflation data in the US on Wednesday, and then pared those gains hours later after the Fed pushed back its expected time frame for rate cuts. Japan’s currency traded around 156.80 to the dollar Thursday morning in Tokyo.

While Ueda has repeatedly said the bank doesn’t target foreign exchange rates, the yen’s reaction to Friday’s decision will be more closely watched than usual after the governor was blamed for spurring the currency’s retreat after the previous gathering in April. In the wake of that meeting, Japan’s currency fell to a fresh 34-year low, prompting the government to conduct the largest ever currency intervention in support of the yen. 

“Doing nothing at all could become a push for further depreciation of the yen,” said Hiroshi Namioka, chief strategist at T&D Asset Management. “This isn’t a situation where the BOJ can just sit tight.”     

The BOJ kept the amount of bond purchases roughly the same even when it abandoned its ultra easy policy settings three months ago with the first rate hike in 17 years. Ueda said at the time that he wanted to see how the market would digest those changes before addressing debt purchases. 

What Bloomberg Economics Says...

“We also expect the central bank to announce it will start reducing JGB purchases — kicking off quantitative tightening. The BOJ has long flagged its intent to shrink its balance sheet. But with only a slim majority forecasting a move at this meeting, the yen could see some upward pressure if our call is on the mark.”

—Taro Kimura, economist

Click here to read the full report. 

The BOJ’s bond operations are under intense scrutiny of late after the bank cut the amount of its bond purchases on May 13, in a move that surprised traders. That sent a fresh reminder of the BOJ’s intention to let the market determine long-term interest rates, a stark change after more than a decade in which the bank was heavily involved in the market via its tools including the yield curve control program.

Any shift in debt buying will only be gradual and in stages, as authorities don’t want to surprise bond market participants, the people familiar said. The board wants to proceed with any changes in a matter-of-fact manner that resembles the Federal Reserve’s approach, with perhaps less rigidity, they said.

Thanks mainly to a persistent weak yen, expectations for a rate hike in July have ramped up. One-third of surveyed economists expect a move next month, with about 60% citing that risk. Investors will listen for clues on the future policy path during Ueda’s press conference.

The BOJ usually releases its policy statement around noon before Ueda briefs reporters at 3:30 p.m. The statement will likely be longer than it was in April in detailing the bank’s assessment of the economy and inflation, as there will be no quarterly economic outlook report this time.

Here is what to watch for

  • There is no strong market consensus on details of any new bond plan including the pace of purchases. With many predicting the reduction to be by ¥1 trillion or less, an immediate cut that’s larger than that amount would likely trigger instant reactions by the yen and bond yields.
  • If the amount of monthly buying goes clearly below the current ¥6 trillion it would suggest quantitative tightening is underway, with a drop in bond holdings coming down the road.
  • While tweaking bond purchases, the bank is likely to stress continuity as it has consistently done even while shifting from its large-scale monetary easing. It will probably signal its readiness to step into the market in the event of a sharp yield rise, while its stance is to let the market determine rates in principle.
  • Ueda will have to perform a balancing act. To avoid fueling a further yen drop he probably wouldn’t want to sound too dovish. At the same time, he wouldn’t want to pencil in a July hike with the economy not yet on a firm footing after a contraction last quarter.
  • The governor has said there will be room for a rate hike if underlying inflation rises in line with BOJ’s expectations. Economists will be gauging his confidence level on the price trend for clues of an early liftoff.

(Updates with yen’s reaction to FOMC meeting)

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