After taking a break on Wednesday for the Emperor’s birthday, the yen could be in for some substantial volatility for the rest of the week. On Tuesday, the BOJ was forced to step in to defend the bounds of its YCC, buying up ¥400B in bonds. The markets are clearly anxious to see when and how Japan will exit its ultra-easing policy.
Answers to those questions could come on Friday as the nominee for the top job at the BOJ is expected to deliver testimony at the upper house of Japan’s parliament. Remember that Kazuo Ueda has been a relatively unknown academic, with hardly any public statements on monetary policy over the last ten years. This makes scrutinizing his outlook a little difficult. But, there are some things that can help give some insight into how the yen pairs might react over the coming days.
First, the data
The main problem the BOJ is facing, of course, is rising inflation. It already doubled the bank’s target in December. January CPI change is forecasted to accelerate to 4.2% from 4.0%, despite a tweak of policy by the BOJ previously.
Japan has for decades kept interest rates low as the BOJ fought deflation for years. Almost the entire tenure of Kuroda at the head of the BOJ has been about getting inflation up. But now that inflation is higher, the BOJ is really uncomfortable, because it’s the “wrong” kind of inflation.
The easing dilemma
Prices have been rising in Japan due to external factors, principally the rising cost of goods and services. That effect was exaggerated by the large drop in the value of the yen last year, making imported goods significantly more expensive. That is seen as “unhealthy” inflation, because it’s not driven by increased domestic demand, fueled by a vibrant economy. In fact, the higher prices could pose an additional drag on the economy.
For this reason, it’s not a simple thing for the BOJ to start hiking like other central banks have. GDP grew by an annual rate of just 0.6% last quarter and is forecast to grow at an anemic 1.8% for this year. Other central banks have hiked substantially and are still expected to be able to skate by with minor economic slowdowns. But if the BOJ were to hike rates even in the relatively slow pace of the ECB, it could have much more severe consequences for the economy.
So tightening, but…
That’s why there was an initial bullish reaction in the yen upon hearing that Ueda was nominated, because it was seen as a move away from Kuroda’s ultra-easing, and Ueda had criticized easing in the past. But that move was short-lived. Ueda gave an interview later in which he affirmed support for the current policy, but admitted that it needed to end sometime in the future.
Ueda’s comments before parliament could follow a similar “dovish” line. While he might agree academically that ultra-low rates are a long-term problem, how to change policy without hurting the economy is a much trickier question. With the government having a majority in Parliament, it’s also unlikely that the Government’s nominee will face especially difficult questions at the hearing.