Bank of Japan (BoJ) preview: Policy settings to remain unchanged, but hawkish bets continue to brew

What to expect at the upcoming Bank of Japan (BoJ) meeting?

The BoJ is set to hold their monetary meeting across 27 – 28 July 2023, with BoJ hawks still finding themselves in the minority camp ahead of the upcoming meeting. Thus far, market-implied policy rates remain heavily priced for a no-change in interest rates through the rest of the year, but following the surprise tweak to its yield curve control (YCC) policy back in December 2022, market sentiments remain highly sensitive to any further tweaks in policy settings as a hawkish indication towards policy normalisation.

For now, comments from BoJ Governor Kazuo Ueda last week still seem to carry some reservations for a policy tweak at the upcoming meeting, indicating that there is still some distance to achieving the central bank's 2% inflation target in a sustainable and stable manner. That has anchored broad market expectations for the central bank to maintain its ultra-loose monetary policy for the time being. The Governor has laid out his stance that, "If our assumption (that sustained achievement of 2% inflation remains distant) is unchanged, our overall narrative on monetary policy remains unchanged”.

Inflation data provides room for more wait-and-see, alongside weaker US dollar

Recent inflation data provides some hopes that pricing pressures, particularly the core-core inflation (excluding fresh food and energy), could be starting to turn the corner. While the headline number for June came in below expectations at 3.3% versus the 3.5% consensus, the core-core aspect saw a downtick for the first time since January 2022, coming in at 4.2% from previous 4.3%.

Granted, a 4.2% read is still more than two-fold that of the central bank’s 2% target and more data points are needed to provide further conviction of a peak in place, but nevertheless, there are hopes that this could mark the start of a declining trend ahead.

Recent weakness in the US dollar could also alleviate some imported cost pressures off Japan. The US dollar has touched its 15-month low in July this year, before a slight recovery over the past week. With the BoJ’s firm stance that the acceleration in inflation has been a cost-push episode, some weakness in the US dollar alongside initial signs of peaking core inflation could provide some grounds for further wait-and-see.

Pressures for a policy shift to remain over coming months

Nevertheless, some hawkish bets will continue to be in place over the coming months, with Japan’s policy normalisation seen as a matter of when, and not if. The Japan's 10-year government bond yield has been heading higher lately, touching its three-month high ever since a pull-ahead in Japan’s May wage growth data.

The implied volatility for Japanese 10-year government bonds, as measured by the JGB VIX Index, has also witnessed a significant surge, potentially reflecting some expectations for huge price fluctuations in the 10-year JGB Futures over the coming weeks.

Upside risks to Japan’s inflation will remain on the radar. Following the shunto wage negotiations in March-April this year, Japan's wage dynamics could be set for a change over coming months. Workers’ nominal wages in May could have provided a glimpse, rising by 2.5% after a revised 0.8% increase in April, with further upside likely to challenge the BoJ’s ‘transitory inflation’ stance.

Oil prices have also seen some signs of strength lately, rising more than 10% in July. Being a net energy importing country, rising global commodity price may fuel some persistence in Japan’s inflation numbers as well. The Bloomberg Commodity Index has increased by 5.3% over the past month.

Fresh inflation projections to provide further clues for policymakers’ views

The upcoming meeting will bring fresh economic projections for Japan’s inflation and growth conditions, with chatters for an upward revision in current FY2023 core inflation forecast to 2.5% from previous 1.8%.

However, greater focus may lie on the longer-term inflation projections for FY2024 and FY2025. Previous projections in April suggest that policymakers do not expect inflationary pressures to stick, with FY2024 just touching its 2.0% target while FY2025 inflation to come in lower at 1.6%. Maintaining the previous forecasts could potentially be looked upon with dovish eyes, while on the other hand, any significant upward revisions to the inflation projections could reignite more bets for a quicker policy shift.

USD/JPY: Past intervention levels remain on close watch

On the daily chart, the USD/JPY remains within an ascending channel pattern since the start of the year as the Fed-BoJ policy divergence remains the main driver for the pair. Despite a 3% recovery for the pair over the past week, much still await as a turn lower in the daily relative strength index (RSI) below the 50 level points towards some near-term exhaustion.

The 145.00-145.80 level will be a key resistance to overcome, with a recent retest marked with a strong bearish rejection back in early-July. To recall, the BoJ has intervened in the currency market at this level back in 22 September 2022, which has seen some policymakers’ jawboning coming into play lately.

On the downside, a key support confluence stands at the 137.60 level (Ichimoku cloud, 100-day moving average, horizontal resistance-turned-support). A continued dovish tone from the BoJ this week could provide some tailwind for the USD/JPY, but should the 137.60 level failed to hold, the 131.50 level could be on watch next.

Nikkei 225: Neckline of double-top formation still being tested

Following a 28% rally since March this year, the Nikkei 225 seems to display a double-top formation lately, as lower highs on its RSI point towards some moderating upward momentum for now. Currently, the index is still attempting to defend the neckline around the 32,400 level, but should the level fail to hold, a retest of the 31,400 level could be on the table. Heading into the upcoming BoJ meeting, the risks for the index will be any hawkish surprise from policymakers, as one may recall how the YCC tweak in December 2022 triggered a 3% intra-day plunge in the index.