The BOJ is widely expected to keep rates unchanged when it finishes its meeting on Thursday. Usually, the focus is on what Governor Kazuo Ueda has to say in the post-rate decision press conference. That is an opportunity to provide some clues for what could be expected of future rate moves.
But, with Ueda sticking firmly to his “uncertainty” script lately, markets might have another point of interest: The growth forecasts. Often, traders can get a feel for what a central bank will do based on its economic projections. Slower economic growth usually implies less inflation, and therefore less need to hike. However, this deduction might be especially complicated when it comes to the BOJ.
Domestic vs International Scenario
Absent the trade war, the economic data in Japan sets the scene to logically expect further rate cuts. The economy is doing, well, OK at least. But, more importantly, inflation is well above target and has actually been increasing. It is escaping from the BOJ’s projections, meaning that the central bank should be under pressure to raise rates.
But, as an export-based economy, Japan is particularly vulnerable to the trade war. Its largest trade partners are China and the US, in that order. And it is additionally in the middle of geopolitical tensions between Washington and Beijing. A sudden slowdown in the economy due to the trade war (particularly if Japan can’t quickly secure a favorable trade deal) would presumably pull down inflation. That means the BOJ has reason to be particularly hesitant about tightening until there is more clarity on the trade front.
The Changing Forecasts
This meeting includes a quarterly update on economic forecasts. The last time the BOJ calculated where it expected the economy and prices to go, none of the tariff announcements were in place. Given the market turmoil since then, analysts expect a cut in the outlook once more.
Prior guidance from the BOJ was for the economy to grow at 0.9-1.0% this year, with inflation coming down to a 2.0-2.3% range. That justified the outlook for further rate cuts at some point later in this year. If the BOJ cuts its growth forecast, this could leave markets pricing in less of a chance of a hike and weaken the yen once more. On the other hand, if it comes hand-in-hand with higher CPI projections, that could mean the BOJ will go through with hiking later in the year as it prioritizes monetary stability over economic growth.
The Potential Market Reaction
Lately, the USDJPY has been moving more on what’s going on in the US than in Japan, as the yen has become a safe haven amidst turmoil in American markets. But with the trade situation resolving, investors could return to American assets, which could put upward pressure on the USDJPY. That could be compounded if the BOJ provides any signals that further hikes will have to wait.
With both the Fed and the BOJ expected to hold in May, the interest rate spread between the two currencies will remain stable. This means markets will have to rely on more volatile events to gauge the outlook for the currency, such as finding a resolution to the trade situation.