Macro Insights: Bank of Japan’s policy tweaks – not yet

The Bank of Japan announcement curbed the enthusiasm of yen bulls for the near term, but options were kept open for the medium to long term. The first meeting of Governor Ueda brought no changes to policy settings, holding the benchmark interest rate at -0.1%, and signalling that the bank will continue with its yield curve control measures for now.

Inflation forecasts were raised across the board, even though the BOJ still expects inflation to moderate in FY2023. Core CPI forecast for FY2023 was raised marginally to 1.8% from 1.6% at the January meeting, and 2% for FY2024 from 1.8% previously. The core-core measure of inflation, which excludes fresh food and energy, saw more drastic upward revisions with FY2023 now expected at 2.5% from 1.8% previously. Ironically, April’s Tokyo CPI, a leading indicator for the nationwide print, surged to fresh over 40-year highs on the core-core measure just before the meeting.

Still, these higher inflation prints mean little as the BOJ wants to wait for signs of wage inflation before taking any policy actions. Despite this year’s spring wage negotiation resulting in 3.8% increase in overall wages, the most since 1993, Ueda seems to be unconvinced that it will be enough to anchor inflation above 2%.

But the central bank also said it will conduct a broad-perspective review of monetary policy over the next one to one and a half years, to study the effects of prolonged accommodative policy on the Japanese economy. While reports of an expected review of policy came in earlier than the policy announcement itself, the timeline reported later during the policy announcement of 1-1.5 years was way longer than what the market had hoped, i.e. tweaks by June/July.

While the review timeline has come in longer-than-expected, this does not mean that there will be no action on policy in the next 18 months. Ueda’s press conference still signalled openness to normalization even within the review framework, and market is likely going to continue to expect tweaks if inflation stays above 3%. Scrapping of forward guidance also signals they want to keep flexibility and keep it easier to tweak policy in a surprise move. Still, it is going to be a very gradual normalization, even if one was to happen, which is a difficult ask for markets that are usually impatient. This suggests that the Japanese yen would go back to being a yield story for now.

Worth noting that Bank of Japan impacts JPY more when yields are sideways to lower elsewhere, and gets less traction if yields re-heat. So, if at all we are forced to mark Fed up to end-2023 policy rate of 5.125% (no rate cuts), USDJPY could run north of 140.00 despite BOJ’s tweaks. But even if BoJ drag feet on tweaks and we start getting recessionary data and Fed marked to 3.00% by early 2024, then USDJPY heads maybe well below 130.00.

For now, the focus will be on the Fed meeting next week with the announcement due on May 3. USDJPY rose above 135.50 following the announcement, and if the Fed comes out more hawkish than expected, we could see USDJPY test the March high of 138. But if global yields continue to slide, we will potentially see yen strengthening. Markets will still continue to expect Ueda to announce some tweaks at the June and July meetings, so that may bring some yen strengthening as well.