The USDJPY has been on the rise this week, aided by the Fed’s hike, but also amid weakness in the yen ahead of a crucial BOJ decision on Friday. There is an unusual amount of unanimity in expecting a rate hike, with the market pricing if further tightening later in the year. Often, this sets up a situation where the market moves ahead of the meeting, provoking a counterintuitive reaction in the currency price afterwards.
This would be the first BOJ action since the Fed’s intervention to stop the yen from weakening and push back against carry trading. It would also raise rates to the highest level in 31 years, but the effect on the currency might be mitigated by other central banks. Instead of narrowing the gap with the Fed, the BOJ’s action will simply keep pace. The market, therefore, is likely to react to secondary effects from the decision.
Japan Inflation Could Jolt the Market
Three and a half hours before the rate decision is announced, Japan will publish its lates inflation figures. The headline CPI change is projected to tick up to 2.1% from 2.0% a month yearlier. Meanwhile, the “core-core” rate (which is broadly equivalen tot the “core” rate in other countries) is projected to stay unchanged at 1.9%.
These rates are essentially in line with the BOJ’s 2.0% target. But, the central bank can justify hikes to prevent further inflation, particularly if the exchange rate deteriorates. But, if the inflation rate is notably below forecast, it would make it harder for the BOJ to present a hawkish case. As a result, the market might react more to the inflation data than the interest rate decision. Note that this time around, the BOJ is not scheduled to issue inflation and growth projections, which makes the data release more important.
The Markets Will Focus on Ueda
Given the market pricing in a 100% chance of a rate hike, the decision itself is unlikely to move the currency pair. The reaction might wait until Governor Kazuo Ueda’s extensive press conference a couple of hours later. The markets are anticipating that he will provide a hawkish message, and support the view of continued gradual rate increases.
The market is pricing in a pause at the next meeting in October, followed by a another rate hike in December. The market reaction will likely depend on the timing, and whether Ueda is hawkish enough to put the expected December hike firmly on the table. The market fully prices in the rate hike between December and January, and a sooner hike would likely support the yen, while the January option could leave the Japanese currency weaker.
The BOJ’s Bond Problem
Japan’s central bank needs to advance cautiously given the high level of government debt and how long rates have been negative. There is considerable debate among experts and, apparently, among BOJ staff on what’s the best option. So far, the BOJ has bet that
hawkish communication will help lower long-term bond yields by alleviating inflation concerns.
However, as interest rates rise, so do long-term bond yields, putting pressure on Japanese financial institutions. As other central banks raise rates, the BOJ is obliged to hike rates to prevent the currency from weakening too much. Given the strong rhetoric that Ueda has been maintaining lately, it’s hard for him to come across as even more hawkish. But there is plenty of room for the market to interpret his comments more dovishly.
