BOJ looks cornered as weakening yen looks likely force policy change

Not surprisingly, BOJ officials on Friday warned that Ueda-san’s comments made earlier in the week that he may reassess the central bank’s ultra loose monetary policy by year-end does not veer off course from its official stance and basically, nothing has changed. Although the comments led to a small drop in JGB yields, it also weakened the yen which later hit its year-lows against the dollar.

There lies the dilemma! By trying to supress long term rates, policy makers are recklessly depreciating the Japanese currency and eroding the nation’s purchasing power. The combination of weak yen and rising energy prices could only exert more inflationary pressures in the months to come, adding more upward momentum to JGB yields. 

This vicious circle can only be broken if and when BOJ gives up on its yield curve control (YCC) and allow the market to determine Japan’s long-term rates. We also think that Japan’s economy looks likely to notably slow in growth from here, weighed down by slowing consumption, stalling capex and weakening exports volumes. Thus, the benchmark ten-year JGB yield would seem unlikely to spike much above 1.5% (from 0.7% currently), at least in the near term should BOJ decide to disband YCC. 

However, we highly suspect that BOJ’s policy stance is heavily influenced by MOF and the government’s need to try to put a lid on Japan’s budget refinancing costs which have exploded to nearly a quarter of total annual spending. With MOF’s estimated financing rate for next term’s budget set at 1.5%, we think this is the line in the sand drawn for BOJ to comply with. 

In other words, we think BOJ is far from being an independent policy setter, nor does it look data dependent given that core inflation in Japan has consistently overshot its projections. If our hunch is correct that it is indeed MOF which is pulling all the strings, then we may need to see a much weaker yen to test the resolve of Japan’s interventionist policies. Come what may, we can’t see this charade continuing beyond this year.