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With No Hints Of Future Easing, Will The BOJ Still Act?
Perspective | 17 April 2014

This article is written by Chris Weston from IG.

On 8 April, the Bank of Japan (BOJ) left its monetary policy unchanged – as expected. What was not expected was the lack of hints from Governor Haruhiko Kuroda on future easing measures of the BOJ. In fact, Kuroda was actually fairly upbeat on his assessment of the Japanese economy and the subsequent strength in the yen confirmed the disappointment.

There is no doubt that the BOJ has significantly helped in weakening the Yen, in turn causing inflation (ex-food) to rise from a deflation low of -0.5 percent in 2013 to an inflation of 1.3 percent in the February release. Having said that, things seemed to have plateaued, a 3 percent increase in the consumption tax (now 8 percent), on 1 April. Traders are now wondering whether the economy will be negatively affected and pullback from here.

The latest Tankan report was part of the reason why traders had expected hints of easing. If one looks at the large manufacturers ‘outlook’ sub-component, the index fell aggressively from 17 to 8. This is significant, the outlook incorporates the tax hike and how it will affect their views on the trading environment. What is important here is the deterioration on the index. It is even more pronounced than in 1997, when the then Japanese government last raised the consumption tax and the economy subsequently fell back into recession as a result.

Corporate Japan Not Overly Optimistic About Inflation

Another piece of information from the survey was company’s estimates on future inflation. As we know the BOJ are trying to engineer inflation of 2 percent by 2015, and from the recent rhetoric from the BOJ, they are on track. The companies surveyed were not so sure though, with the consensus estimating inflation of 1.5 percent in a year, followed by 1.7 percent over a three- and five-year period. These same companies expect USD/JPY to average 99.48 over the 2014/15 financial year.

Governor Kuroda seemed to take a more optimistic view on the Tankan report, suggesting the numbers from corporate Japan were higher than the forecasts from local economists. However, given the market reaction, it seems there was a clear disconnect between the BOJ, the economist community and the markets. Of course it is when we get this sort of disagreement that we get volatility and naturally this provides opportunity. Governor Kuroda, stated that “Japan’s economy has continued to recovery moderately as a trend, albeit with some fluctuations due to the consumption tax”. This did not seem like a central banker ready to announce an increase in its bond and exchange-traded fund buying programme, which was duly noted by traders.

Traders Asking Where To For The Yen?

Traders are now asking where to now for the yen? Well, according to investment banks like UBS and Morgan Stanley, the BOJ is still likely to ease monetary policy further. Though perhaps not during the May to July window as previously expected, and will now look to July through to September. Deutsche Bank has a slightly longer time frame, expecting further easing to occur after October, as they expect the bank to lower its inflation forecasts in the October meeting.

It appears we have hit somewhat of a crossroad for the yen in the short-term. With USD/JPY trading in a 101.50 to 103.50 side-ways range since the end of January, it is unlikely that the yen would have helped push imported inflation up too much. Weakness in the yen effectively puts purchasing power in its export partner’s hands, thus gives them added incentive to buy Japanese goods and effectively export their inflation to Japan. Of course there is more to inflation than the ‘tradeables’ component, but that is a key area that the BOJ are targeting. So if the yen is not weakening then it is harder to promote this inflation.

The other aspect is that China has been weakening the Chinese yuan through moving the USD/CNY mid-point higher, through its daily ‘fix’ operation, while buying US dollar in the process. With the People’s Bank of China having accumulated the US dollar, they would be ‘recycling’ these holdings by subsequently selling US dollar, notably against the yen and euro. This is also working against the BOJ.

If these investment banks are correct, it could suggest the near-term threat of the BOJ action is low. In turn, for the JPY to significantly weaken, we may need to see other currencies materially strengthen through dynamics specific to them. However, if we pay attention solely to Japan, the March inflation (due on 25 April) will be closely watched and readings below 1.3 percent could get the market talking about easing again. From here the next BOJ meeting takes place on 30 April, which will give the BOJ a chance to provide the market with its updated consumer price index projections. This meeting will once again give the market an indication of whether they will be looking to ease further in the future, although, we may need to really wait until 14 July. This will give the BOJ plenty of time to assess how the economy is fairing with sales tax being in play for many months.

USD/JPY pulling below 98.00 could also be trigger for an increase in its easing bias.

What is interesting is the consensus (source: Bloomberg) in the market for USD/JPY to trade up to 110.00 by fourth quarter of 2014. This seems to be a promising and interesting ride for the rest of the year.

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