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Japan Inflation and the YCC Rumors

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Japan will release some key data over the coming days that could provide some directionality for the JPY. The yen hasn’t been acting all that “normally” recently, as traders hang on comments from Japanese officials that might indicate intervention to support the currency.

To make matters more confusing, the head of the BOJ, Kazuo Ueda, has said some things that appear to be contradictory. There’s a ball of forex yarn here that needs to be untangled to get a better idea of where the yen could be headed in the medium-to-long term.

First, the data

Tomorrow, Japan will publish its trade balance which is expected to see a dramatic reduction in the trade deficit to just ¥46.7B from ¥1.37T reported in May. Japan typically has relatively large fluctuations in its trade statistics, but if the forecast is correct, it would be the smallest deficit since the latter part of 2021. The weakness of the currency (and brief recovery earlier this year) have been a key factor affecting the trade balance, which is an important component for the BOJ’s decision-making.

The shrinking deficit is expected to be because imports are forecast to decline while exports are expected to grow. Part of that dynamic is seen as a result of the weaker yen meaning that exports are priced at a higher value. On the other hand, the shrinking imports are a sign of lack of dynamism in the economy. The erosion of purchasing power from a weaker currency could mean Japanese citizens are buying fewer things. That would be a worrying sign for the BOJ.

What’s the BOJ up to?

Just last Sunday, the Governor of the BOJ admitted that the weakness in the yen was a concern, and that the bank could take measures to address it. He used more technical speech, of course, talking about restoring market pricing. But the takeaway is what mattered for the market reaction. Just two days later, on Tuesday, he appeared to backtrack, saying that the BOJ is committed to easing.

This changing commentary shows the dilemma of the BOJ, which wants to keep easing in order to support the economy. That means not worrying about a weaker yen, because that helps exports. But the weaker yen has contributed to rising inflation, and slowing the economy. So the BOJ would be worried about a weaker yen.

Clearing up the situation

Ueda has repeatedly said that he wants to see inflation “sustainably” rising at the target rate of 2%. Inflation has been higher than that for months now. What he means is that the current bout of high inflation is seen as “temporary”, and the result of non-market driven yen weakness that has raised the cost of imported goods. “Non-market driven” here means things like carry trade and bets that the BOJ won’t intervene as the currency weakens. The BOJ is trying to cajole markets into getting the yen higher without actually having to do anything to strengthen the yen.

If inflation turns around and starts rising, however, the BOJ might have to come to the conclusion that they can’t have their cake and eat it too. That might prompt a move towards shoring up the yen, such as widening the YCC again. Japanese annual June inflation is expected to tick up to 3.3% from 3.2% prior.

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