Article / 08 July 2016 at 1:50 GMT

BoJ unlikely to be let off the leash with USDJPY

Managing Director / Technical Research Limited
New Zealand
  • The Bank of Japan will issue its updated economic forecasts on July 29
  • Its assessment that inflation will reach its 2% target during fiscal 2017 is not credible
  • A further reduction in the deposit rate to minus 0.30% may be an option
  • But there is unlikely to be any FX intervention unless the markets become disorderly

By Max McKegg

Bank of Japan Governor Haruhiko Kuroda spoke at a regional bankers' meeting yesterday with USDJPY traders hoping he would offer some insights into the bank’s thinking post-Brexit and, in particular, the monetary policy implications of the awkward rally in the yen. But, in inscrutable central-banker fashion, all he offered up were innocuous remarks such as “Japan’s economy is expected to expand moderately as a trend”. 

It seems the Governor wants to give nothing away ahead of the bank’s policy review meeting on July 28-29 when new economic forecasts will be presented. Market expectations are high that more easing measures will be announced at that time but, as the last two easings only squeaked through on a 5-4 vote, Kuroda is probably wise not to second-guess what his board member colleagues might decide.
It’s also likely Kuroda wanted to save any thoughts he had for today’s meeting of the BoJ, the Financial Services Industry and the Ministry of Finance, where the agenda includes a discussion of what should and can be done about the exchange rate, if anything.
As this graphic shows, Japan’s monetary policy appears to be pushing on a string. The BoJ’s balance sheet continues to expand at a steady pace and, incredibly, is set to match the size of Japan’s total GDP by year end. The massive government bond purchases are having “the desired effect” of lowering interest rates right across the yield curve – but the exchange rate isn’t supposed to be rising at the same time.

 Source: Pension Partners

All together now

One explanation is that everyone else is playing the same game and bond markets are rallying world-wide, brought about by either central bank buying, as in Japan, or simply by market forces. In this race to the bottom, it’s hard to get out in front. And Japan isn’t even the front runner: that dubious honour goes to Switzerland where bond yields are negative out to 50 years.
So interest rate differentials aren’t giving traders much incentive to sell yen.


Source: ANZ Bank

No FX intervention likely if market stays orderly 

The Swiss could show the Japanese a thing or two about how to keep an exchange rate down. Ever since the Swiss National Bank swallowed a dead rat and abandoned the EURCHF peg in January 2015, it has had reasonable success in holding the franc steady via periodic (and quiet) interventions in the FX market. 

 Holding steady ... the Swiss could show the Japanese a thing or two about
how to keep an exchange rate down. Photo: iStock

But the Swiss are a special case: Japan is a member of the G7, and fellow members are watching it like a hawk to make sure market forces prevail and no currency “manipulation” takes place. Of course, some action by the Bank of Japan would be sanctioned by the G7 if the FX market became “disorderly” – for example a 4 or 5 big figure move in USDJPY over a couple of days. But if the cross were to amble its way down to, say, 95 in the next few weeks, that amble wouldn’t constitute disorderly market behaviour.
What to do then?
We will find out on July 29, not before. That’s when the Bank of Japan will issue its updated economic forecasts. Its current assessment is that inflation will reach the 2% target “during fiscal 2017” (starting April 1 that year). That’s not credible now. The bank’s inflation benchmark, the Consumer Price Index less fresh food, has slipped back into negative territory on an annual basis and the so called core-core rate (which excludes both food and energy prices) could be headed for the same fate. That’s because the effects of the 2014-15 depreciation of the yen are starting to drop out of the annual calculation, as are last year's price rises in durable goods such as TVs.
The minutes of the last policy board meeting held June 15-16 said: “If it becomes more likely that the timing of annual CPI reaching around 2% will be delayed, the bank will need to reiterate its commitment toward achieving 2% inflation to the public and the market by taking additional monetary easing measures."
Additional measures at the July 29 meeting are likely to include a further reduction in the deposit rate to minus 0.30% and an expansion of the ETF and REIT programs. Increasing the pace of government bond purchases is more problematic. The key point is that FX intervention will not be part of the package – unless the markets oblige by becoming disorderly. 


Source: Reserve Bank of Australia. Create your own charts with SaxoTrader; click here to learn more 
As a good citizen member of the G7, the Japanese government is unlikely to let the Bank of Japan off its leash to thrash around in the FX market. So USDJPY traders should not hold their breath waiting. More likely the Ministry of Finance will twist the bank’s arm to ease monetary policy again at the end of this month with the aim of weakening the exchange rate through more indirect channels.
 – Edited by Gayle Bryant

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.
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