Policy Divergence and Intervention Watch as BoJ Meeting Looms (July 31st)
Monday, 24 June, Week 26: The Japanese Yen has been on a depreciatory trend for the past five months, primarily driven by the Bank of Japan’s (BoJ) commitment to its ultra-loose monetary policy. This report will delve into the factors influencing the Yen’s trajectory, examining the interplay of fiscal and monetary policies, economic indicators, and geopolitical events. The upcoming BoJ meeting on July 31st is a key event that could significantly impact the Yen’s future direction.
Currency
The Japanese Yen has been under persistent downside pressure for the past five months, primarily due to the divergence in monetary policy between the BoJ and other major central banks. While the US Federal Reserve, the Swiss National Bank, the European Central Bank, and the Bank of Canada have either maintained hawkish stances or initiated policy easing, the BoJ has remained steadfast in its commitment to ultra-loose monetary policy. This policy divergence has led to a widening interest rate differential, making the Yen less attractive to yield-seeking investors.
January - April 2024: The Yen depreciated steadily against the US dollar, reaching a 34-year low of 160.24 on April 29th. This prompted the Japanese government to intervene in the currency market, selling US dollars and buying Yen to stem the decline.
May - June 2024: The Yen recovered somewhat following the intervention, but the underlying depreciatory trend persisted. The BoJ’s decision to maintain its key interest rate at 0% to 0.1% at its June meeting, while indicating a possible reduction in bond purchases in July, did little to bolster the Yen.
Looking ahead to the next five weeks, the Yen’s trajectory will likely be influenced by the following factors:
BoJ Meeting (July 31st): The BoJ’s upcoming meeting is a pivotal event for the Yen. The market will closely scrutinise the Bank’s commentary and actions regarding its bond-buying program. Any indication of a concrete plan to taper bond purchases could provide upward support for the Yen. Conversely, a continuation of the current ultra-loose policy could exacerbate the Yen’s weakness.
US Economic Data: Strong US economic data, particularly inflation figures, could further bolster the US dollar, putting downside pressure on the Yen. Conversely, weak US data could lead to a correction in the US dollar, potentially providing some respite for the Yen.
Geopolitical Risks: Heightened geopolitical tensions, particularly in the Middle East, could trigger a flight to safety, benefiting the Yen as a safe-haven currency. However, the Yen’s sensitivity to risk aversion has diminished in recent years due to the BoJ’s ultra-loose policy.
Fiscal Policy
Japan’s fiscal policy remains expansionary, with the FY2024 draft budget outlining a continued increase in government spending, particularly in areas such as social security, defence, and child allowances. The government aims to stimulate economic growth and address social challenges, including the declining birthrate. However, this expansionary fiscal policy is contributing to Japan’s already high levels of government debt, which stood at 263.9% of GDP in 2022.
The draft budget states that “Based on the Basic Policy on Economic and Fiscal Management and Reform, the government will reduce new government bond issuance while sustaining expenditure reform initiatives and normalising expenditures structurally.”
The government is relying on increased tax revenue and the issuance of government bonds to finance its spending. The draft budget projects a modest increase in tax revenue, but the bulk of the financing will come from bond issuance. This continued reliance on debt financing raises concerns about fiscal sustainability and could potentially limit the government’s ability to respond to future economic shocks.
The FY2024 budget also highlights the government’s commitment to promoting wage increases. The budget includes measures to support wage hikes in the healthcare and welfare sectors, as well as for nursery teachers and public school teachers. The government recognizes the importance of wage growth in stimulating consumption and achieving a virtuous economic cycle. The budget states that “‘Wage increases that overcome price hikes’ should be realised to lead the brightest economic signs in three decades to bring about a virtuous economic cycle.”
In the next five weeks, the focus will likely be on the implementation of the FY2024 budget and the government’s efforts to promote wage increases. The success of these initiatives will be crucial in determining the effectiveness of Japan’s fiscal policy in supporting economic growth.
Economics
The Japanese economy is facing a confluence of challenges, including sluggish growth, persistent deflationary pressures, and demographic headwinds. The government’s expansionary fiscal policy and the BoJ’s ultra-loose monetary policy have provided some support, but structural reforms are needed to address the underlying issues.
Economic Growth
Japan’s GDP contracted by 0.5% quarter-on-quarter in Q1 2024, reversing from a 0.1% growth in Q4 2023. This contraction was driven by weak private consumption, which fell for the fourth consecutive quarter, and sluggish capital expenditure. Net trade also dragged on growth, with exports declining more than imports.
The BoJ’s April 2024 Outlook Report projects that Japan’s economy will “keep growing at a pace above its potential growth rate,” with real GDP growth forecast at 1.3% to 1.4% for fiscal 2023 and 0.7% to 1.0% for fiscal 2024. However, the report acknowledges “high uncertainties surrounding Japan’s economic activity,” including developments in overseas economies and commodity prices.
In the next five weeks, key economic indicators to watch include:
Retail Sales (June): Retail sales data for June, due on July 27th, will provide insights into consumer spending patterns and the impact of wage increases and government measures.
Industrial Production (May): Industrial production data for May, due on June 27th, will shed light on the manufacturing sector’s performance and the effects of supply chain disruptions.
Labour
Japan’s labour market remains tight, with the unemployment rate holding steady at 2.6% in April 2024. However, wage growth has been sluggish, with the year-on-year rate of change in nominal wages per employee increasing only moderately.
The BoJ’s April 2024 Outlook Report projects that wage growth will “increase as a trend, partly reflecting price rises,” but acknowledges that “there remain uncertainties over the extent to which moves to reflect wage developments in selling prices will become widespread.”
Key labour market indicators to watch in the next five weeks include:
Unemployment Rate (May): The unemployment rate for May, due on June 27th, will provide an update on the health of the labour market.
Jobs-to-Applications Ratio (May): The jobs-to-applications ratio for May, due on June 27th, will gauge the balance between labour supply and demand.
Price Changes
Japan’s inflation rate has been rising, with the annual inflation rate accelerating to 2.8% in May 2024 from 2.5% in April. This was driven by a steep upswing in electricity prices as energy subsidies ended. Core inflation, which excludes volatile food and energy prices, also increased to 2.5% from 2.2% in April.
The BoJ’s April 2024 Outlook Report projects that the year-on-year rate of increase in the CPI (all items less fresh food) will be “in the range of 2.5-3.0 percent for fiscal 2024 and then be at around 2 percent for fiscal 2025 and 2026.” The report acknowledges that “underlying CPI inflation is expected to increase gradually,” but notes that “there remain uncertainties regarding this outlook.”
Key inflation indicators to watch in the next five weeks include:
CPI (June): The CPI for June, due on July 18th, will provide an update on inflation trends and the impact of rising energy prices.
Tokyo CPI (July): The Tokyo CPI for July, due on July 26th, is a leading indicator of nationwide inflation trends.
Trade
Japan recorded a trade deficit of JPY 1,221 billion in May 2024, narrowing from JPY 1,382 billion in May 2023. This was despite exports growing faster than imports. Outbound shipments jumped by 13.5% year-on-year, while inbound shipments expanded by 9.5%. The stronger export performance was driven by robust sales to major trading partners, notably the US and China.
The BoJ’s April 2024 Outlook Report projects that exports and production will “return to an uptrend, mainly due to a pick-up in global demand for IT-related goods.” However, the report also notes that “there are uncertainties over how inventory adjustment pressure on some goods will affect overseas economic activity and prices.”
Key trade indicators to watch in the next five weeks include:
Balance of Trade (June): The balance of trade data for June, due on July 17th, will provide an update on Japan’s export and import performance.
Monetary Policy
The BoJ’s monetary policy remains ultra-loose, with the Bank maintaining its key short-term interest rate at 0% to 0.1% and continuing its large-scale bond-buying program. The Bank’s stance is based on its assessment that underlying inflation is still below its 2% target and that the economy needs continued support.
However, the BoJ is facing increasing pressure to adjust its policy. The widening interest rate differential with other major central banks is weighing on the Yen, and rising inflation is eroding households’ purchasing power. The Bank’s Summary of Opinions from its June meeting reveals that “upside risks to prices have become more noticeable” and that “it is necessary for the Bank to continue to closely monitor relevant data in preparation for the next MPM.”
The BoJ’s June meeting also saw a significant development, with the Bank deciding by an 8-1 majority vote to “reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets.” The Bank plans to “collect views from market participants and, at the next MPM, will decide on a detailed plan for the reduction of its purchase amount during the next one to two years or so.”
The upcoming BoJ meeting on July 31st will be crucial in determining the future direction of monetary policy. The market will be looking for signals from the Bank regarding the timing and scale of its bond purchase reduction. Any indication of a concrete plan to taper bond purchases could be seen as a hawkish shift and could lead to upward support for the Yen. Conversely, a continuation of the current ultra-loose policy could further weaken the Yen.
Geopolitics and Market Themes
Russia-Ukraine War
The ongoing Russia-Ukraine war continues to weigh on global economic sentiment, contributing to uncertainty and volatility in financial markets. The war has disrupted supply chains, pushed up energy prices, and exacerbated inflationary pressures.
Key Developments:
Russia has intensified its offensive in eastern Ukraine, making incremental gains.
The West has imposed further sanctions on Russia, targeting its energy sector and financial institutions.
Market Impact:
The war has contributed to risk aversion in financial markets, benefiting safe-haven assets such as the US dollar and the Swiss franc.
The Yen has also benefited from safe-haven flows at times, but its sensitivity to risk aversion has diminished due to the BoJ’s ultra-loose policy.
Middle East Tensions
Geopolitical tensions in the Middle East have escalated, with increased Houthi attacks on commercial shipping in the Red Sea and the Indian Ocean. These attacks threaten to disrupt global trade and push up energy prices.
Key Developments:
The Houthis have targeted oil tankers and other commercial vessels, raising concerns about supply disruptions.
Israel has responded with airstrikes on Houthi targets in Yemen.
Market Impact:
The attacks have contributed to volatility in oil prices, with Brent crude futures trading above $80 per barrel.
The Yen has benefited from safe-haven flows at times, but its sensitivity to risk aversion has diminished due to the BoJ’s ultra-loose policy.
Global Inflation
Inflation remains a major concern for policymakers worldwide, with price pressures persisting in many economies. Central banks are grappling with the challenge of taming inflation without stifling economic growth.
Key Developments:
Inflation in the US has moderated somewhat, but remains above the Federal Reserve’s 2% target.
Inflation in Europe is also elevated, with the European Central Bank signaling further interest rate hikes.
Market Impact:
High inflation has led to volatility in financial markets, with investors concerned about the impact on corporate earnings and economic growth.
The US dollar has benefited from the Federal Reserve’s hawkish stance, while the Yen has weakened due to the BoJ’s ultra-loose policy.
Conclusion
The Japanese Yen’s trajectory in the next five weeks will be shaped by a complex interplay of factors, including the BoJ’s monetary policy decisions, US economic data, and geopolitical risks. The upcoming BoJ meeting on July 31st is a pivotal event that could significantly impact the Yen’s direction.
Upward Support Scenario
The Yen could come under upward support if the BoJ signals a concrete plan to taper its bond-buying program at its July 31st meeting. This would be seen as a hawkish shift by the Bank and could lead to a narrowing of the interest rate differential with other major central banks. A hawkish surprise from the BoJ could trigger a sharp appreciation in the Yen, particularly against the US dollar.
Indifference Scenario
The Yen could remain under indifference if the BoJ maintains its current ultra-loose policy at its July 31st meeting. This would likely keep the interest rate differential with other major central banks wide, limiting the Yen’s upside potential. However, the Yen could still benefit from safe-haven flows if geopolitical risks escalate.
Downside Pressure Scenario
The Yen could come under further downside pressure if the BoJ maintains its ultra-loose policy and US economic data remains strong. This would likely lead to a further widening of the interest rate differential, making the Yen less attractive to investors. The Yen could also weaken if the Japanese government intervenes in the currency market to weaken the Yen and support exports.
References
Bank of Japan: https://www.boj.or.jp/en/
Ministry of Finance, Japan: https://www.mof.go.jp/english/
Cabinet Office, Japan: https://www8.cao.go.jp/english/index.html
Trading Economics: https://tradingeconomics.com/
Reuters: https://www.reuters.com/
Bloomberg: https://www.bloomberg.com/