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Japan October Inflation: Keeping the BOJ on Edge

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The USDJPY has fallen substantially over the last week, fueled by expectations that the BOJ is moving away from ultra-easing. But the path might have quite a few bumps along the way. One of them that could shake up market expectations is tomorrow’s release of Japan’s CPI change.

Inflation in Japan has been above target for a year and a half, and is once again expected to be above for the 19th consecutive month. In most cases, that would all but guarantee tightening from the central bank. But, while Japan’s higher inflation did initially come with more economic growth, that has faltered recently. Now, some economists are arguing that the BOJ’s reluctance to change is starting to hurt the economy.

Ripping Up the Playbook

Japan’s economy has been in the doldrums for decades at this point, and investors had become complacent in how they invested in and traded Japanese assets. But the situation has changed dramatically since the pandemic, and the old way of trading is being reassessed. This could have profound implications for how the yen reacts to the market situation.

The Japanese stock market has seen increased volatility in recent months, which is attributed to a rise in “tourist investors”. That is, people investing in Japan with little experience in the market, causing outsized reactions. From a forex perspective, that means more funds buying up yen, and increasing the downward pressure on dollar and Euro pairs.

The New Investing Plan

Investors had been betting on Japan’s aging economy and deflationary environment, which meant holding bonds (JGBs) and trading against the currency. Not surprisingly, the yen lost value substantially in those circumstances.

But in recent months, Japanese consumer spending has increased. Some investors are seeing new opportunities in what’s seen as the potential for a more vibrant services and consumer economy driven by inflation. The theory is that if prices are going up, consumers will be more willing to spend now instead of save, which will increase economic dynamism. The growing economy and higher CPI change would naturally push the BOJ into behaving more like the Fed.

Is the BOJ Ready for a Change

Economists estimate that inflation will average around 2% next year. But that’s only because there is expectation that the BOJ will do something about pushing it down to that level. That’s a significantly higher rate than the around 0% that has been the theme over the last couple of decades, while the BOJ has kept rates down as low as possible. The bank is  hesitant to change out of that mindset, which has kept the yen weak. But that doesn’t mean the change won’t happen eventually.

Japan is expected to see its October inflation rate move back up to 3.2% from 3.0% prior. During the month, the yen was at its weakest point of the year, which contributed to the pricing pressure. The core rate, which is more closely tracked by the BOJ, is also expected to rise to 2.9% from 2.8% prior. The question now is whether the BOJ can hold out to its planned tightening start next year, or whether the data will force its hand.

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