It’s a holiday in Japan, and with the BOJ away, the markets have gone ahead and substantially weakened the yen. The USD/JPY moved to the highest it has been since the end of June. The EUR/JPY was even more dramatic, rising to levels not seen since 2008. One of the main differences between the two is that the ECB is expected to keep raising rates, while most of the market believes the Fed is done.
Normally, the BOJ would offer to buy a certain amount of JGBs during the trading session in order to defend the YCC and keep policy in line. But, Japanese traders are off their desks, drying up liquidity, and making larger moves possible. Additionally, next week there are a couple of key data points coming out of Japan, with the long weekend seen as a potential opportunity to position ahead of them.
What’s coming up?
Tuesday sees the first of the major data releases, which is the first look at Q2 GDP figures for Japan. Quarterly growth is expected to accelerate to 1.0% from 0.7% reported in the first quarter. That would bring annual GDP growth to 3.2% from 2.7% prior. That would be the highest growth rate since late 2017 (if discounting the unconventional growth following the covid rebound).
This is especially important for BOJ policy, because the main issue that it has been facing is the lack of “organic” growth in inflation. That is, when the economy grows, the increase in money circulation naturally causes inflation to rise. Higher inflation in Japan in recent months has been attributed to increased cost of imported goods caused by a weaker yen. If the economy is starting to pick up, inflation might start growing organically, and that would put the BOJ in a position where it would have to step away from its ultra-easing policy.
What about inflation?
Speaking of consumer prices, Japan is set to report its July CPI change on Friday. The headline number is expected to rise to 3.4%, up from 3.3% and above the 2.0% target from the BOJ. The core rate is expected to moderate a bit to 3.1% from 3.3% prior. The BOJ has insisted that inflation is expected to come down through the course of the year, which would make it unnecessary to stop with the ultra easing.
Most recently, the BOJ once again tweaked its YCC mechanism in a way that it said was policy neutral, but in reality targeted the weaker yen. Allowing yields on government debt to appreciate more would make the yen more desirable as a currency, in theory. But, apparently the BOJ has lost some credibility with the market, because the yen immediately weakened following the central bank’s action. With the USDJPY back to probing the 145 level, it’s expected that once again Japanese authorities will come out to talk about how they are watching the exchange rate.
What could turn the yen around?
So far, comments from authorities expressing concern over the FX rate have yet to dissuade the market. The last time the exchange rate pushed above these levels, the BOJ was forced to intervene on behalf of the Ministry of Finance in an effort to halt the weakness of the yen. The subsequent turnaround in the exchange rate, however, wasn’t so much from the intervention, but expectations that the BOJ would finally give up on its easing.
A similar situation could develop in the coming days if the market once again challenges Japanese authorities. But, with improving data, the BOJ might be in a better position to actually announce that it would ease up on the accommodative policy. That could finally turn the exchange rate around.
