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The Japanese Yen: USD/JPY and GBP/JPY Rise after BoJ Sees Inflation Target Moving Further Away

Image © Leonid Andronov, Adobe Stock

- JPY weakens broadly after BoJ takes axe to inflation forecasts.

- Downgrades undermine hopes of policy normalisation in 2019. 

- But analysts say a global slowdown will support safe-haven JPY.

The Yen fell Wednesday after the Bank of Japan (BoJ) slashed its inflation forecasts for a fourth consecutive time, undermining the case for a withdrawal of monetary stimulus over the coming quarters and prompting traders to dump the currency by the bucket load. 

BoJ Governer Haruhiko Kuroda said WednesdayWednesday the board will keep Japan's main interest rate at -0.1% and the long term interest rate, which is the ten year bond yield, will be kept around 0%. It will also go on buying exchange traded funds, real estate investment trusts, commercial paper and corporate bonds just like before.

However, the bank now expects inflation to come in at at just 0.9% for 2019, down from the 1.4% forecast given in its October monetary policy report, while the 2020 forecast was cut by 10 basis points to 1.4%. Lower oil prices are the main reason for the downgrades.

This puts the 2% inflation target further from view, which means there is even less reason for the BoJ to contemplate an increase in its bond yield target or an interest rate rise over the coming the coming quarters. And some analysts say that even those new forecasts are still too optimistic. 

"Is there anyone who still believes the Bank of Japan (BoJ) with its inflation forecasts? I think not even the BoJ still truly believes that the inflation target of 2% will actually be reached in the foreseeable future – even if it courageously insists that a positive “momentum” is maintained," jeers Thu Lan Ngueyn, an analyst at Commerzbank.

Changes in interest rates are normally only made in response to movements in inflation, but impact currencies because of the push and pull impact they have on capital flows as well as their allure for short-term speculators. 

Rising rates, or hints of them being in the cards, are a draw for capital flows that offers support to a currency and vice versa.

Above: USD/JPY rate shown at daily intervals.

The BoJ has given new meaning to the term "unorthodox monetary policy" since 2013, as it has cut rates to negative levels and rapidly expanded the money supply through quantitative easing and other measures designed to stoke inflation. 

However, even after this and buying large portions of the government bond and stock markets, Japanese inflation remains a long way below 2%. Core inflation, which excludes volatile food and energy items, was just 0.4% in December. 

"This means that the normalisation of its monetary policy is therefore a long way off. However, we see indications that the BoJ is increasingly eyeing rate hikes, regardless of inflation developments," says Nguyen.

Lower forecasts are a problem for the Yen because for a while now markets have grown steadily accustomed to the idea the BoJ would reconsider some of its extreme policy measures either this year or next.

Markets are looking for change because the BoJ's negative interest rates, record low bond yields and large holdings of financial assets are no longer having the desired effect on inflation and have themselves come to be viewed as a risk to financial stability.

"There was no signal that an imminent changed in BoJ policy was likely. The BoJ’s current loose policy stance has helped to keep the yen significantly undervalued," says Lee Hardman, a currency analyst at Japan's MUFG

BoJ Governor Haruhiko Kuroda said Wednesday the impact of lower oil prices on inflation will be temporay, but gave no indication he is contemplating a meaningful change in policy.

This could weigh on the Yen throughout the year, particularly if the economy slows, as that would further undermine the inflation outlook. And there are good reasons for economists to think that growth might weaken a touch in 2019. 

Notably, the government of Tokyo is pushing for another increase in the VAT sales tax rate to take place late in 2019. And the last such increase that was implemented back in 2014 was enough to push the economy into recession. 

"While the developments increase downside risks for Japan’s economy in the year ahead, the yen is more likely to strengthen if fears over the global slowdown intensify further," says MUFG's Hardman.

Above: Pound-to-Yen rate shown at daily intervals.

Despite the downbeat interest rate and monetary policy outlook in Japan, most analysts are forecasting the Yen will strengthen in 2019 because of the poor shape of the global economy. Any downturn in global economic growth would likely see market demand for so-called safe haven assets rise.

The International Monetary Fund cut is forecasts for global growth this year and next on Monday, citing economic weakness in China and the Eurozone. But most analysts also expect the U.S. economy to slow in 2019.

Japan's Yen is a complex creature that on the one hand, benefits from its status as a safe-haven during times of stress and uncertainty, and on the other hand trades according to the whims of its central bank like any other currency. 

"One thing should be clear though, and that is the fact that the JPY’s depreciation potential is very limited in the current environment. If concerns about a global recession turn out to be even remotely correct the BoJ would be one of the few central banks to have hardly any scope left for significant monetary policy easing," says Commerzbank's Nguyen. 

Nguyen says that with inflation almost non-existent and the prospect of a return to deflation ever present the Yen would be the safe-haven of choice for investors if the global economy were to slow further during 2019. 

This is because deflation lifts the value of a currency by increasing its purchasing power and the consumer price outlook would be undermined by a global slowdown. Not only that, but the BoJ is close to having run out of all kinds of ammunition that might be able to actually stoke meaningful price pressures.

Commerzbank forecasts the USD/JPY rate will fall to 104 before year-end while the Pound-to-Yen rate is projected to end 2019 at its Wednesday level of 142. 

MUFG also forecasts the USD/JPY rate will fall to 104 this year, but says the Pound-to-Yen rate will rise to 149.30 rather than stabilise at current levels.

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