ECB’s policy mistake, Bank of Japan comes next

Yen at risk of a retreat if BOJ stays ultra-dovish

The Japanese yen has had strong rally, rising by over 4% against the USD in December. But the yen remains a “BOJ problem with a Fed solution”, and gains have come primarily on the back of a slide in Treasury yields. However, part of the strong December gains have also come from speculations around a potential BOJ pivot as early as December or January. BOJ Governor Ueda hinted recently that it will become difficult to keep interest rates negative next year. This pushed the markets to price in odds of a tweak at the BOJ’s December 19 meeting, however he walked back later saying that BOJ officials see little need to end negative interest rates next week.

As we noted in this article last week, we continue to expect BOJ to be gradual and modest with their policy tweak. Pivoting before seeing the wage data could impact their credibility, while waiting too long could mean they will need to tighten policy when other global central banks may have already started to cut rates.

The setup going into next week’s decision will be a tough one for BOJ. After considerable gains this month, JPY will need BOJ to deliver hawkish to sustain the momentum. If BOJ maintains its ultra dovish stance and stays aways from any hints on a potential end of negative rates, that could bring back yen weakness. USDJPY, which closed below its 200DMA yesterday, could move back above the key level around 142.50 and likely move towards 145. Yen weakness could also be pronounced against EUR and GBP, where central banks have stay away from dovish pivots for now.

A low probability outcome could be if the BOJ adds to the speculation on a potential January move, then USDJPY could break below 140 and move into the 137-138 area.

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