Bank of Japan (BoJ) preview: Odds of a July rate hike priced at a coin flip

What to expect at the upcoming BoJ meeting?

The Bank of Japan (BoJ) is set to hold their monetary meeting across 30 – 31 July 2024.

At the previous June meeting, the BoJ kept short-term rates unchanged at a range of 0-0.1% for the second straight meeting, following its first rate hike in 17 years back in March this year. That said, the central bank was quick to guide for more patience and was careful not to fuel market expectations that it is heading into a monetary tightening cycle.

Odds of a July rate hike priced at a coin flip

With inflation exceeding the central bank’s 2% target for two years, alongside promising signs of pick-up in Japan’s wages, expectations for further rate increase are priced at almost a coin flip at the upcoming meeting.

The key reservations that support more dovish bets are that Japan’s real household spending is still in a sluggish state, most recently falling short of market expectations with a 1.8% year-on-year contraction in May. That may not offer policymakers the confidence about the strength of the Japan’s economy to push through with higher rates just yet, with them potentially choosing to buy some time to seek further validation from upcoming economic data.

Plan on reduction of bond purchases to be unveiled

In the previous meeting, the BoJ has guided that it will lay out a detailed bond taper plan at the upcoming meeting, which will cover a period of around one to two years. Earlier survey suggests some bond market participants were calling for a reduction in monthly government bond purchases to around two trillion to three trillion yen, while others called on the bank to keep buying around four trillion yen. The scale of reduction from the current six trillion yen purchases in government bonds per month will be on close watch, which may reflect the central bank’s tolerance for bond yield increases.

Policymakers will face the task of having to balance any rate move with the amount of bond taper to send an overall signal to markets of their policy stance. A no-change in rate, accompanied with a higher-than-expected bond taper, may seem to be the consensus approach among BoJ watchers to limit any yen weakness while giving policymakers more policy flexibility in waiting for future economic data. Any extremely cautious move in cutting back its bond buying may give markets a dovish signal, which could see market participants pricing for a weaker yen.

Upcoming meeting to bring fresh quarterly outlook report

Fresh quarterly growth and price forecasts will be released at the upcoming policy meeting. The previous projections in April 2024 saw an upward revisions in inflation forecasts for FY2024 and 2025, with policymakers expecting inflation to hover close to the 2% target rate over coming years. Since then, new inflation figures have been broadly stable above target, which could see the BoJ retain its current price projections.

Some weakness in growth data (1Q gross domestic product (GDP) downgrade, subdued Purchasing Managers' Index (PMI), weak household spending) may drive downside risks to its growth projections. But if the central bank is able to retain its previous April view for a moderate recovery into FY2025, markets may still see further policy normalisation as the likely path. Any significant downward revisions in GDP projections however could see markets pricing for a delay in rate hikes potentially into the fourth quarter this year.

USD/JPY: Narrowing US-Japan yield differentials to present some headwinds

The USD/JPY tends to track the US-Japan 10-year bond yield differentials closely, but recent moves seem to present a divergence, which could be set to weigh on the pair as monetary policies between US and Japan continue to take on a different direction over the coming months. Previous round of yen-buying interventions around the 158.40-159.40 range seem to suggest Japanese’s authorities strong resolve in defending this level, which may serve as a near-term ceiling for the pair.

For now, a key upward trendline connecting higher lows since the start of this year has been broken down, which suggests a potential trend reversal in place. Its daily relative strength index (RSI) has also dipped to its lowest level since March this year, which suggests near-term bearish momentum. Further retracement may leave the 154.60 level on watch next, where a horizontal key support has held the pair up on at least three previous occasions.

Nikkei 225: Cooling off from its previous all-time high

After a touch of record high at the 42,488 level, the rally in the Nikkei has cooled off lately, in line with the broader risk environment which saw some unwinding in tech. On the weekly chart, a bearish pin bar formation is in place, which may pave the way for the recent retracement to deepen towards the 38,800 level, where the next support confluence stands. This is where a lower channel trendline coincides with its daily Ichimoku Cloud support.

For now, its daily moving average convergence/divergence (MACD) has registered a bearish crossover, while its daily RSI is back to retest the key 50 level, which could suggest sellers taking greater control.