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Message from my broker (maybe it will be interesting):
The recently at times ambiguous comments of the governor of the Japanese central bank Haruhiko Kuroda caused confusion on the market about the Bank of Japans future approach. In our view the continued very low inflation levels in Japan in particular continue to point towards a continuation of the ultra-expansionary monetary policy and thus a weaker JPY medium to long term.
Will the Bank of Japan (BoJ) follow in the footsteps of the Fed, the ECB and the Bank of England and also start eyeing its exit from its expansionary monetary policy soon? That is a question the market has been considering quite intensely for some time and the answer to this question is decisive for the JPY exchange rates. The speculation was caused by BoJ governor Haruhiko Kuroda with his speech last November in which he mentioned the so-called reversal interest rate theory, according to which an excessively expansionary monetary policy could be counter-productive as it increases pressure on margins in the banking sector and thus could negatively affect lending. For some market participants this was a signal that the BoJ might soon move on to a less expansionary monetary policy. Since then, speculations about a normalization of monetary policy in Japan have remained stubbornly in the market and have recently been further fuelled by the unfortunate communication of the top Japanese central banker, Kuroda.
Our forecast that JPY will depreciate this year and next is based on the assumption that the BoJ will maintain its low interest rate policy for a long time still, above all much longer than Fed and ECB. Our reasoning behind this is that inflation developments in Japan will remain too weak to justify the start of a normalisation of monetary policy. At present the BoJs preferred measure of core inflation stands at only 0.4%. The BoJ, however, has pledged to maintain its expansionary monetary policy until inflation has overshot its 2% target for some time so as to ensure that inflation expectations are anchored at higher levels. So far it is a long way away from that. If the BoJ was to start normalising its monetary policy before this target has been reached, it would lose credibility which would make it considerably more difficult to reach its inflation target longer term.
That makes the comments of the BoJ governor all the more surprising. Kuroda had explained that the target of allowing inflation to overshoot was mainly tied to an extension of the monetary base, i.e. the continuation of the asset purchases, rather than the current strategy of controlling the yield curve. In this context, Kuroda did not rule out the possibility of adjusting the yield target before reaching the 2% target. At the same time, however, he regularly emphasizes for example, at the BoJ meeting last week that the current monetary policy strategy of the BoJ is geared to the yield target it introduced in September 2016 and that the bond purchase volume is based on it. It is fitting that the central bank has reduced its purchases over the past year. The total purchase volume in 2017 amounted to around JPY 60 tn., although the BoJ continues to officially set a target price of JPY 80 tn. per year. Following Kuroda’s statements, it is more unclear than ever what the monetary policy instrument prioritised by the BoJ is: the yield target or bond purchases?
Ultimately, the decisive factor for the exchange rate is whether the BoJ will soon increase its yield target. If the market were to expect interest rates to rise in Japan, for example because the BoJ believes that its monetary policy will continue to be expansionary due to its bond purchases, the JPY would appreciate. An early interest rate hike would not only jeopardise the credibility of the inflation target, but would also create additional downward pressure on inflation due to the stronger yen. The BoJ would therefore need to have very good reasons if it were to take this risk.
One reason that is conceivable is the imminent global rate reversal which might cause upside pressure for yields in Japan and make it more difficult for the BoJ to defend its yield target. This reason does not convince us, as we consider the strategy of defending the yield curve to be credible and sustainable. The BoJ has proven repeatedly since the introduction of the yield target that it is willing to purchase as many assets as is required to prevent a significant rise in yields. The larger the number of bonds the central bank holds the easier it should be for it to control yields on the market even.
Another possible argument would be that the BoJ would be unwilling to decouple itself from a global trend. In our view that is exactly what might help it to reach its inflation target though. If it keeps its interest rates lower for much longer than other central banks JPY would depreciate notably and create price pressure in Japan via more expensive imports.
Is it possible that concerns about the banking sector might cause the BoJ to hike interest rates? This argument is not completely fat-fetched. The central bank introduced the yield curve control strategy in 2016 with one aim being the steepening of the yield curve. The curve had become so flat as the result of a strong fall of yields at the long end that the BoJ was increasingly concerned about the sustainability of financial functioning and resulting negative effects on the economy. Kuroda’s reference to the reverse rate theory could also be an indication that the BoJ is now paying more attention to developments in the banking sector. In fact, the founders of the theory argue that an increase in interest rates can make sense if the burden on banks becomes too great due to low interest rates. This could explain why Kuroda did not want to rule out an increase of the yield target before the inflation target was reached. With such an interest rate hike, however, the central bank would not signal the beginning of a normalization of its monetary policy, but would simply optimize the effect of its continued expansionary monetary policy. However, the central bankers do not currently see any negative impact on the banking sector, which is why we consider it unlikely that the yield target will be raised soon.
Accordingly, we are sticking to our forecast that the BoJ will hold on to its expansionary course until inflation has risen above its target and remains there for a while. This should not be the case until the end of 2019. As the US central bank will continue its normalisation course and as the ECB will start considering rate hikes next year we expect that JPY will depreciate against USD and EUR until year-end 2019.