Focus on the Bank of Japan’s Policy Divergence
The Bank of Japan’s (BoJ) divergence from other major central banks amid an unrelenting storm of global inflationary headwinds deserves a closer look. BoJ Governor Haruhiko Kuroda’s dovish stance could either be seen as pioneering or risky, depending on where you stand on monetary policy.
It’s tempting fate to have such a weak Yen vulnerable to a challenging currency exchange environment in which the US Dollar reached multi-decade highs against the JPY this month. Possibly one of the biggest risks is a selloff against the Yen in the currency markets, which could lead to weaker spending power for consumers in Japan and weigh on consumer spending in the short-to-medium term.
Under different circumstances, a weaker Yen would lead to a bigger trade surplus for Japan because it would support higher exports. The current situation is more difficult because of the high fuel import costs which are eroding the country’s trade balance, which fell to 58.9 billion Yen from 229 billion Yen previously, the lowest level recorded in the month of August.
Between the two safe harbours of the USD and the JPY, the USD beacon is currently shining brightest as the Federal Reserve is on an interest rate hiking spree - with good reason. It appears that core inflation in the US isn’t about to recede in the short term after September’s CPI figure showed core inflation at the level of 0.6 percent, unchanged from the previous month. On an annual basis, the US consumer price index rose to 6.6 percent in September, versus 6.3 percent in September last year.
Compared to the US economy, Japan’s economy is more adapted to deflation than inflation. Relatively speaking, Japan’s inflation rate was 3 percent in August, still under the 10-year high of 4 percent seen in 2014. While inflation is rising, it stands at less than half the levels seen in economies like the US, EU and UK at the time of writing.
The expectation for Japan’s Consumer Price Index report due out on Friday, October 21, is for core inflation to have reached 3 percent in September compared with 2.8 percent for the same period last year.
Will the dove turn hawkish?
What level would core inflation have to reach for the BoJ to start moving away from its dovish stance? One scenario is the level of 4 percent, the highest since 2014. Combined with high import fuel prices pressuring fiscal policy makers, a core inflation of 4 percent or over would likely give the BoJ cause to consider its position. This is an increasingly likely scenario if September’s core inflation forecasts turn out to be accurate and the rate keeps climbing.
Traders and investors are also eyeing the BoJ’s interventions in the currency markets to support the Yen. So far, the central bank stepped in last month to balance the volatility in the Yen markets to the tune of 2.8 trillion JPY. More recently, Finance Minister Shunichi Suzuki said Japan is ready to take the appropriate action towards Yen currency crosses volatility.
Next BoJ policy meeting
The BoJ’s next policy meeting takes place October 27-28. Will the central bank maintain its key interest rate at the level of minus 0.1 percent, where it's been since 2016? If core inflation rises higher than expected in September, there may be new signals from the BoJ, so this is an important meeting for traders to watch.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
