The Very Complicated BOJ Interest Rate Decision
As the USDJPY hits another multi-decade high above the 155 handle, the BOJ is set to meet and decide on policy tomorrow. The weakness of the yen will be the necessary topic of discussion, and there is quite a bit of anticipation in the market over what will be done about it. The problem for the BOJ is that they are in a really complicated situation.
The market is betting that Japanese authorities can’t really do anything about stopping the fall of the yen. And the market could be right, as there are a lot of obstacles set up for the central bank. To make matters worse, the timing will take one of its key tools to jog the market off the table. This leaves virtually everyone expecting the BOJ to leave policy unchanged.
Why the BOJ’s Hands are Tied
What’s driving the yen’s weakness is carry trading. As other central banks boosted their rates and the BOJ didn’t in the wake of global inflation, the interest rate differential made it profitable to borrow yen to buy dollars (and Euros, but dollars are the counterpart in the USDJPY). That means there are loads of traders selling yen, weakening the currency.
The way to fix that problem would be to narrow that interest rate gap, by raising rates. The BOJ hiked for the first time in more than a decade at the last meeting – and the yen only got weaker. Why? Because the market believes that the BOJ is out of ammunition and can’t hike again without creating other problems for the economy.
Why Hiking is Not an Option
The Japanese economy has been so long under low interest rates that it is not ready to deal with higher rates. The US had a taste of the problem last year when the Fed’s tightening caused a crisis in regional banks. The BOJ is taking great pains to reassure its financial system that interest rates will rise very slowly and “rationally”. Having already raised rates, another hike in the near term would likely shake that slow path confidence going forward.
To this end, Governor Kazuo Ueda has insisted that the BOJ will be data dependent. And the data shows that the Japanese economy is sputtering, which is a bad time for monetary tightening. And that slow growth in the economy is expected to translate into anemic inflation, pushing Japan back to where it was for the last decade before the pandemic. That’s when the BOJ was desperately trying to get inflation to rise and the economy to take off.
It’s Down to the Forecasts
One of the ways that the BOJ could push the markets is to suggest that another rate hike was likely. And economists believe that monetary policy statement will actually say something like that. The problem is that this meeting coincides with the quarterly economic forecasts. The consensus is that the BOJ’s own forecasts will show a slow economy and inflation sticking around the target. In other words, that there won’t be the conditions to justify another rate hike. That would seriously take the wind out of any threats that the BOJ could use to push the market into supporting the yen.
That leaves only the prospect of intervention on the table. Japanese authorities have repeatedly tried to get the market to behave by threatening to intervene – but stopping short of actually doing so. The thing is, there is relief on the horizon, just not on the side of Japan. If the Fed were to get around to its easing, then that would start closing the rate gap and support the yen. Which is why the upcoming PCE data and its implication for the future of the rate path could have a bigger impact on the USDJPY than the BOJ Interest Rate decision.
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