BOJ to Hold Despite Weaker Yen

Amid a busy week in which practically all major central banks hold meetings, the BOJ will also decide on its monetary policy on Thursday. As the yen (USDJPY) has weakened substantially over the last couple of weeks, the BOJ has come under increased pressure to remedy the situation. However, the consensus among economists and the market is that it will keep policy unchanged.

Normally, if a central bank wanted to influence the market without actually changing policy, it could do so by “jawboning”. That is, giving hawkish (or dovish) rhetoric to incentivise traders to behave in the way the central bank wants. However, the BOJ has already been very hawkish over the last several meetings. It’s hard to see how Governor Kazuo Ueda can cajole the markets to expect tightening more than he already has, beyond explicitly saying there will be a hike at the next meeting, something that all analysts believe is impossible.

Influencing the yen (USDJPY)

That doesn’t mean that BOJ can’t or won’t influence the currency. The central bank has many concerns, with the exchange rate being only one of them. But that’s the main focus for forex traders, and therefore the main issue here. Given how sensitive the market is at the moment, even if the BOJ does nothing, it could still cause a reaction in the markets.

The pressure on the BOJ to address multiple problems in the Japanese economy has spilt over into the currency markets, prompting traders to pre-position for something to happen. This could lead to something akin to a relief rally, since once the meeting is over, it will be another month before the BOJ is likely to change its monetary policy. Traders can return to focusing on the data and ongoing economic factors.

Gauging the Market Reaction

Judging in which direction the market will react, however, is a much more difficult proposition. The BOJ is still on a very gradual path of rate hikes, as upward wage pressure continues to threaten price stability. But with high debt levels and massive financial-sector exposure to Japanese long-term bonds, the BOJ has to be extremely cautious about tightening.

The issues that the yen (USDJPY)  is facing now are potentially transitory and exacerbated by speculation amid a strong market desire to restart carry trading. The high cost of petroleum resulting from the war in Iran is likely to force importers to sell more yen, pushing the price down. But, the war – or at least the restrictions on oil – could be over fairly quickly, reversing the effect.  Central bank monetary policy is poorly calibrated to deal with those kinds of issues. For that reason, policymakers in Japan have sought to rely on the threat of intervention from the Ministry of Finance (executed through the BOJ), in conjunction with the US.

The Fed, the BOJ and the War Raise Odds of Intervention

All this comes to a head as the FOMC is also meeting to decide policy this week. If the Fed is more hawkish than anticipated on Wednesday, it could cause the USDJPY to rise ahead of the BOJ meeting on Thursday. This could force other entities to step in, so the BOJ doesn’t have to address the issue with monetary policy.

Japan’s Ministry of Finance has a limited amount of US dollars it can sell, which makes its potential intervention less effective. Meanwhile, the US has the theoretical capacity to sell an infinite amount of dollars, which is why “coordinated” or “joint” intervention is much more powerful. With the dollar strengthening since the war started, the US has more room and motivation to help Japan by weakening its own currency. But that assumes the war will continue for a long time, since an end to the conflict is widely expected to weaken the dollar back to near its February levels. Financial policy could provide some insight into the military outlook.

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