Bank of Japan Signals Policy Shift, Yen Braces for Uncertainty

The Bank of Japan's July meeting, US/Eurozone monetary policy, and geopolitical risks will significantly impact the yen and related exchange rates.

Tuesday, 16 July, Week 29

Spending Spree: Japan's Expansionary Fiscal Policy Fuels Growth

Japan's fiscal policy has taken a decidedly expansionary turn over the past five months, as the government prioritises economic growth amidst a fragile recovery. The FY2024 budget, approved in April, outlines a significant increase in spending, particularly in areas like childcare support and wage increases. This spending spree aims to stimulate domestic demand and foster a virtuous cycle of economic expansion. The budget also includes provisions for disaster relief following the Noto Peninsula earthquake in January.

The current fiscal policy can be characterised as expansionary, with the government leveraging its fiscal capacity to support the economy. The increase in spending is financed through a combination of tax revenues and new government bond issuance. The projected increase in bond issuance has raised concerns about Japan's already massive public debt, but the government maintains that the spending is necessary to secure a sustained recovery.

Over the next five weeks, the focus will likely remain on the implementation of the FY2024 budget and the government's efforts to balance its expansionary policies with fiscal sustainability. Market participants will be closely watching for signs of progress in key spending initiatives and the impact of increased bond issuance on the yen and interest rates. The government's communication regarding its fiscal strategy will be crucial for maintaining market confidence.

Fiscal policy plays a pivotal role in shaping Japan's macroeconomic landscape. It influences aggregate demand, economic growth, and inflation. The current expansionary fiscal policy is aimed at boosting domestic demand and supporting the Bank of Japan's efforts to achieve its price stability target. However, the increase in bond issuance could lead to higher interest rates and a weaker yen, potentially offsetting some of the positive effects of the fiscal stimulus. Forex traders need to closely monitor fiscal policy developments as they can significantly impact the yen's valuation and the overall attractiveness of Japanese assets.

Economic Crossroads: Japan's Recovery Faces Headwinds

Japan's economic recovery has been a mixed bag over the past five months, with positive signs emerging alongside persistent challenges. While corporate profits and business investment have shown resilience, private consumption has been lacklustre, weighed down by rising prices and a decline in real wages. The recent earthquake in January also had a negative impact on consumer spending.

The current economic situation can be described as a fragile recovery. The economy is expanding, but the pace of growth is moderate and vulnerable to external shocks and domestic headwinds. The Bank of Japan remains cautious, acknowledging the fragility of the recovery and the need for continued policy support.

The next five weeks will be crucial for gauging the resilience of Japan's economic recovery. Key economic data releases, such as GDP growth, inflation, and retail sales, will provide insights into the strength of domestic demand and the impact of rising prices on consumer spending. The Bank of Japan's policy decisions and communication will also be closely watched for clues about the central bank's assessment of the economy and its willingness to provide further stimulus.

Economic Growth:

• Japan GDP Growth Rate (QoQ): Measures the quarter-on-quarter change in real GDP. Previous: 0.1%, Consensus: -0.5%, Latest: -0.5%, Forecast: 0.8%. The economy contracted in Q1 2024, reversing from a slight expansion in Q4 2023. The outlook for the next five weeks and beyond remains uncertain, with the BoJ forecasting growth of 0.8% in Q2 2024.

• Japan GDP Growth Annualised: Measures the annualised change in real GDP. Previous: 0.4%, Consensus: -1.9%, Latest: -1.8%, Forecast: 0.3%. The economy contracted on an annualised basis in Q1 2024, reversing from a slight expansion in Q4 2023. The outlook for the next five weeks and beyond remains uncertain, with the BoJ forecasting a return to growth in Q2 2024.

Labour Market:

• Japan Unemployment Rate: Measures the percentage of the labour force that is unemployed. Previous: 2.6%, Consensus: 2.6%, Latest: 2.6%, Forecast: 2.6%. The unemployment rate has remained steady at 2.6% for the past four months. The BoJ expects the labour market to remain tight in the coming months.

Inflation:

• Japan Inflation Rate (YoY): Measures the year-on-year change in the consumer price index (CPI). Previous: 2.5%, Consensus: 2.5%, Latest: 2.8%, Forecast: 2.8%. Inflation accelerated in May 2024, driven by rising energy prices and the full removal of government subsidies. The BoJ expects inflation to remain elevated in the coming months but to moderate towards its 2% target in the second half of fiscal 2025.

• Japan Core Inflation Rate (YoY): Measures the year-on-year change in the core CPI, which excludes fresh food but includes energy. Previous: 2.2%, Consensus: 2.6%, Latest: 2.5%, Forecast: 2.6%. Core inflation picked up in May 2024, driven by rising energy prices. The BoJ expects core inflation to remain elevated in the coming months but to moderate towards its 2% target in the second half of fiscal 2025.

Housing Market:

• Japan Housing Starts (YoY): Measures the year-on-year change in the number of new housing starts. Previous: 13.9%, Consensus: -6.1%, Latest: -5.3%, Forecast: -6.3%. Housing starts declined in May 2024, reversing from a sharp increase in April. The outlook for the housing market remains uncertain, with rising interest rates and construction costs potentially weighing on demand.

Business Sentiment:

• Japan Machinery Orders (MoM): Measures the month-on-month change in core machinery orders, which exclude orders for ships and from electric power companies. Previous: -2.9%, Consensus: 0.8%, Latest: -3.2%, Forecast: 1.0%. Machinery orders fell sharply in May 2024, indicating a potential slowdown in capital spending. The outlook for business investment remains uncertain, with rising interest rates and global economic headwinds potentially weighing on sentiment.

• Japan Reuters Tankan Index: Measures business sentiment among large manufacturers. Previous: 9, Consensus: 12, Latest: 6, Forecast: 8. The Reuters Tankan index fell to a four-month low in June 2024, reflecting concerns about rising costs and the impact of the auto industry scandal. Manufacturers are more optimistic about the coming months, with the index expected to rebound in September.

• Japan Tankan Large Manufacturers Index: Measures business sentiment among large manufacturers. Previous: 11, Consensus: 12, Latest: 13, Forecast: 10. The Tankan index rose to a two-year high in Q2 2024, reflecting an improving economic outlook. Large manufacturing firms expect business conditions to improve further in Q3 2024.

• Japan Manufacturing PMI: Measures manufacturing activity. Previous: 50.4, Consensus: 50.1, Latest: 50.0, Forecast: 50.1. The manufacturing PMI remained in expansionary territory in June 2024, albeit at a slower pace. The outlook for the manufacturing sector remains uncertain, with global economic headwinds and supply chain disruptions potentially weighing on activity.

• Japan Services PMI: Measures services activity. Previous: 53.8, Consensus: 49.8, Latest: 49.4, Forecast: 49.8. The services PMI fell into contractionary territory in June 2024, reversing from a strong expansion in May. The outlook for the services sector remains uncertain, with rising prices and labor shortages potentially weighing on activity.

• Japan Industrial Production (MoM): Measures the month-on-month change in industrial production. Previous: -0.9%, Consensus: 2.0%, Latest: 3.6%, Forecast: 1.8%. Industrial production rebounded strongly in May 2024, reversing from a decline in April. The outlook for industrial production remains uncertain, with global economic headwinds and supply chain disruptions potentially weighing on activity.

Consumer Sentiment:

• Japan Consumer Confidence: Measures consumer sentiment. Previous: 36.2, Consensus: 36.5, Latest: 36.4, Forecast: 36.0. Consumer confidence edged up slightly in June 2024, but remained near a six-month low. The outlook for consumer spending remains uncertain, with rising prices and a decline in real wages potentially weighing on sentiment.

• Japan Retail Sales (YoY): Measures the year-on-year change in retail sales. Previous: 2.4%, Consensus: 2.0%, Latest: 3.0%, Forecast: 1.8%. Retail sales accelerated in May 2024, indicating continued strength in consumer spending. The outlook for retail sales remains uncertain, with rising prices and a decline in real wages potentially weighing on demand.

Foreign Trade:

• Japan Current Account: Measures the balance of payments on current account. Previous: ¥3398.8B, Consensus: ¥1737.6B, Latest: ¥2051B, Forecast: ¥2100.0B. The current account surplus narrowed in April 2024, but remained substantial. The BoJ expects the current account surplus to remain large in the coming months, supported by a strong primary income surplus.

• Japan Balance of Trade: Measures the difference between exports and imports of goods. Previous: ¥-465.6B, Consensus: ¥-1300B, Latest: ¥-1221.3B, Forecast: ¥-200.0B. The trade deficit narrowed in May 2024, but remained substantial. The BoJ expects the trade balance to fluctuate in the coming months, depending on global demand and commodity prices.

• Japan Exports (YoY): Measures the year-on-year change in exports of goods. Previous: 8.3%, Consensus: 13.0%, Latest: 13.5%, Forecast: 12.8%. Exports surged in May 2024, driven by robust demand from major trading partners. The outlook for exports remains uncertain, with global economic headwinds and supply chain disruptions potentially weighing on demand.

The Yen at a Crossroads: Will the BoJ Tighten its Grip?

Japan's economics are intricately linked to its unique monetary policy stance, which has been a key driver of the yen's valuation in recent years. The Bank of Japan's ultra-loose monetary policy, characterised by negative interest rates and large-scale asset purchases, has kept borrowing costs low and supported economic growth. However, it has also created a wide interest rate differential with other major economies, putting downward pressure on the yen.

The current economic situation in Japan is characterised by a fragile recovery, with positive signs emerging alongside persistent challenges. While corporate profits and business investment have shown resilience, private consumption has been lacklustre, weighed down by rising prices and a decline in real wages. The recent earthquake in January also had a negative impact on consumer spending.

Over the past five months, Japan's economy has experienced a mixed bag of economic data, with some indicators pointing to a strengthening recovery while others suggest lingering weakness. The Bank of Japan has maintained its accommodative monetary policy stance, keeping interest rates low and continuing its asset purchase program. However, the BoJ has signalled a potential shift towards policy normalisation, acknowledging the need to address rising inflation and potential financial imbalances.

Looking ahead, the outlook for Japan's economy remains uncertain. The Bank of Japan expects the economy to continue recovering, but the pace of growth is likely to be moderate and vulnerable to external shocks and domestic headwinds. The central bank's policy decisions and communication will be crucial for shaping market expectations and influencing the yen's valuation.

Key Economic Indicators:

• Japan GDP Growth Rate (QoQ): Measures the quarter-on-quarter change in real GDP. Previous: 0.1%, Consensus: -0.5%, Latest: -0.5%, Forecast: 0.8%.

• Japan GDP Growth Annualised: Measures the annualised change in real GDP. Previous: 0.4%, Consensus: -1.9%, Latest: -1.8%, Forecast: 0.3%.

• Japan Inflation Rate (YoY): Measures the year-on-year change in the consumer price index (CPI). Previous: 2.5%, Consensus: 2.5%, Latest: 2.8%, Forecast: 2.8%.

• Japan Core Inflation Rate (YoY): Measures the year-on-year change in the core CPI, which excludes fresh food but includes energy. Previous: 2.2%, Consensus: 2.6%, Latest: 2.5%, Forecast: 2.6%.

• Japan Current Account: Measures the balance of payments on current account. Previous: ¥3398.8B, Consensus: ¥1737.6B, Latest: ¥2051B, Forecast: ¥2100.0B.

• Japan Balance of Trade: Measures the difference between exports and imports of goods. Previous: ¥-465.6B, Consensus: ¥-1300B, Latest: ¥-1221.3B, Forecast: ¥-200.0B.

• Japan Exports (YoY): Measures the year-on-year change in exports of goods. Previous: 8.3%, Consensus: 13.0%, Latest: 13.5%, Forecast: 12.8%.

The BoJ's Balancing Act: A Policy Shift on the Horizon?

Japan's monetary policy has been a key focus for forex traders in recent months, as the Bank of Japan navigates the challenges of supporting economic growth while addressing rising inflation. The BoJ's ultra-loose monetary policy, characterised by negative interest rates and large-scale asset purchases, has kept borrowing costs low and supported economic growth. However, it has also contributed to a weakening yen and fueled concerns about potential financial imbalances.

The BoJ's June meeting saw the central bank maintain its key short-term interest rate at around 0% to 0.1%, as widely expected. However, the board indicated that it may consider how to start reducing bond purchases at its July meeting. This signal of a potential shift towards policy normalisation, coupled with the recent depreciation of the yen, has injected volatility into the currency market.

Over the next five weeks, the BoJ's policy decisions and communication will be closely scrutinised by forex traders. The central bank's July meeting will be a key focal point, with market participants looking for clues about the BoJ's assessment of the economy, its tolerance for inflation, and its plans for future policy adjustments. The BoJ's communication regarding its policy intentions will be crucial for shaping market expectations and influencing the yen's valuation. As stated in the Bank of Japan's June 14th Statement on Monetary Policy, "The Bank decided, by an 8-1 majority vote, that it would reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets."

Monetary policy is a crucial determinant of currency valuations, as it influences interest rate differentials, capital flows, and inflation expectations. A tightening of monetary policy, such as raising interest rates or reducing asset purchases, can lead to currency appreciation, while an easing of policy can lead to depreciation. Forex traders need to closely monitor monetary policy developments as they can significantly impact the yen's valuation and the overall attractiveness of Japanese assets.

Navigating the Storm: Japan's Macroeconomic Risks

Top Three Risks Over the Past Five Months:

1. US Inflation Rollercoaster (March - July 2024): Persistent inflation in the US has created uncertainty for the global economy and impacted currency valuations. While recent signs of cooling inflation have raised hopes of a potential Fed pivot, Fed Chair Powell's comments suggest the central bank may continue its tightening cycle. This tension between cooling inflation and the Fed's potential continued tightening has injected volatility into the USD's trajectory, impacting the USD/JPY exchange rate.

   • Key Developments:

     • US CPI peaked at 3.5% in April before easing to 3% in June.

     • Core PCE inflation, the Fed's preferred gauge, slowed to 2.6% in May.

     • Markets are pricing in a September rate cut by the Fed, with two more reductions expected before year-end.

2. Japanese Yen Intervention (March - July 2024): The Japanese yen has been under pressure due to the Bank of Japan's ultra-loose monetary policy, which has created a wide interest rate differential with other major economies. This has prompted the Japanese government to intervene in the currency market to support the JPY, injecting volatility into its valuation.

   • Key Developments:

     • The JPY depreciated past 158.5 per dollar in July, nearing multi-decade lows.

     • The BoJ indicated it may consider how to start reducing bond purchases at its July meeting.

     • Market speculation suggests the Japanese government intervened in the currency market on multiple occasions in recent months.

3. Australian Dollar's China Dependence (April - July 2024): The Australian dollar has been impacted by concerns about a slowing Chinese economy, as China is Australia's largest trading partner. Weaker Chinese demand has weighed on commodity prices, which has in turn impacted the AUD, pushing it to multi-month lows against the USD. However, the latest COT report shows a significant increase in net long positions among Asset Managers/Institutional traders, suggesting a potential shift in sentiment.

   • Key Developments:

     • China's economy grew by 4.7% in Q2 2024, the slowest since early 2023.

     • The AUD has been trading near multi-month lows against the USD.

     • The RBA has been raising interest rates, but the pace of tightening has slowed.

Top Three Risks Over the Next Five Weeks:

1. Fed Decision and US Data (Week 31): The Federal Reserve's interest rate decision in Week 31 will be a major focal point for the market. If the Fed signals a more dovish stance than expected, the USD could weaken, potentially impacting the USD/JPY exchange rate. Conversely, if the Fed maintains its hawkish rhetoric, the USD could strengthen. Key US economic data releases, such as CPI, retail sales, and employment data, will also be closely watched for clues about the Fed's next move.

2. ECB Meeting and Eurozone Inflation (Week 30): The European Central Bank's monetary policy meeting in Week 30 will be another key event for the market. The ECB is widely expected to hold interest rates steady, but any hints about the future path of monetary policy could impact the EUR, potentially affecting the EUR/JPY exchange rate. Eurozone inflation data will also be closely monitored, as persistent inflation could prompt the ECB to adopt a more hawkish stance.

3. Japanese Yen Volatility (Weeks 29-33): The Japanese yen is likely to remain volatile over the next five weeks, as the market continues to assess the outlook for BoJ monetary policy and the potential for further government intervention. Any signs of a shift in BoJ policy or renewed intervention could trigger sharp moves in the JPY.

Conclusion

Japan's macroeconomic outlook remains uncertain, with a confluence of factors influencing the yen's trajectory. The Bank of Japan's potential shift towards policy normalisation, coupled with global economic headwinds and geopolitical risks, creates a complex landscape for forex traders.

Action Points for the Coming Weeks:

• Monitor the BoJ's July meeting: Pay close attention to the BoJ's policy decisions and communication for clues about the central bank's assessment of the economy, its tolerance for inflation, and its plans for future policy adjustments.

• Watch for signs of JGB purchase tapering: The BoJ's decision to reduce its purchase amount of JGBs could have a significant impact on the yen and long-term interest rates.

• Assess the impact of US and Eurozone monetary policy: Developments in US and Eurozone monetary policy could influence the USD/JPY and EUR/JPY exchange rates.

• Monitor geopolitical risks: Escalating geopolitical tensions could trigger a flight to safety, potentially impacting the yen and other safe-haven currencies.

Sources:

• Bank of Japan

• Ministry of Finance, Japan

• Cabinet Office, Japan

• Ministry of Internal Affairs & Communications, Japan

• Statistics Bureau of Japan

• Ministry of Economy Trade & Industry (METI)

• Ministry of Land, Infrastructure, Transport and Tourism, Japan

• Trading Economics

• Reuters

• Bloomberg

• S&P Global

• Tankan Sponsored by Thomson Reuters

• IMF "World Economic Outlook"

• OECD "Economic Outlook 114"

• CFTC COT Reports