Bank of Japan review: where next?

Investors clearly appear to be looking past this short-term guidance, focusing on the longer term outlook. With the tapering of Japan Government Bond (JGB) purchase underway and the remaining of the quantitative and qualitative easing (QQE) with yield curve control (YCC) still in place, the question truly lies with when the Bank of Japan (BoJ) will shift.

Dovish Jan meeting

The highly accommodative monetary policy had been maintained in the first meeting of 2018, a contentious one by means of guidance following the BoJ’s recent reduction of long-dated bond buying. Reactions towards the observation at the start of the year triggered a selling into USD/JPY as the market widely perceived it as a hawkish signal from the BoJ, believing that the bank is on its way to cut back accommodation.

Going on the defensive, BoJ Governor Haruhiko Kuroda reaffirmed the public during the post-meeting on the central bank’s commitment towards stimulus. The governor took it a step further, clarifying that adjustments of the ten-year yield target may not be first in line despite rising inflation expectations. This rhetoric drove only a mild rise for USD/JPY by about 0.3% before the market took to yen bids once again.

Overlooking the comments, the parsing of the outlook did derive the upgrade in inflation view by the BoJ to 'more or less unchanged', once again triggering a USD/JPY downturn. With the BoJ’s inflation target being the key constraint for the removal of accommodation, this improvement in outlook reinforces expectation for the direction that BoJ would eventually take.

What can the BoJ deploy?

The improvements to growth and inflation expectations, coupled with the BoJ’s recent stance certainly inspired some analysts to bring forward their expectations for the BoJ to remove accommodation. Tapering of JGB purchases had already been one noticeable change last year.

Moving forward, with the likes of the Fed leading the exit from post-crisis support, even the most dovish of central banks may inevitably have to follow suit as yields rise in tandem. This leads to the expectation for the BoJ’s YCC to take precedence in changes, ahead of alterations to their negative interest rate policy (NIRP), with some forecasting the former to commence as early as September. A more likely presumption remains with the year end, backed by both the BoJ’s recent rhetoric and the apparent inflation target gap, one to keep the market debating.

Markets to watch

While the timing for policy changes will likely be the perennial question in the median term, the direction is of little doubt. Front-loading of monetary policy expectations from both the BoJ and Fed’s ends keeps USD/JPY on a downward bias. Meanwhile, the timing of the expectation for accommodation removal will likely be the one fiddling with the speed of decline. Post meeting, the USD/JPY pair has already sunk past $110, and pushed past further below the $109 figure on USD weakness. Watch for a retest of September 2017’s $107.3 lows into the mid-year.

The instinctive direction for the Japanese equity market would likewise be lower as exporters came under pressure, although renewed interest in the growth potential of the market may provide some support. A trade in line with yen strength should nevertheless reap returns.