BOJ Preview: Slim chance for a tweak in YCC policy

Major global central banks have embarked on aggressive rate hikes but nothing seems to impact the Bank of Japan’s (BOJ) intent to continue with its ultra-loose monetary policy. The recent big falls in the Japanese yen remain a headache for the central bank, with USD/JPY hitting 24-year highs above 135.50 earlier this week.

Will the central bank shake its hand-off on FX or tweak the YCC policy?

The BOJ is likely to emerge as a dovish outlier among major global central banks by keeping the benchmark policy rate steady at -10bps on Friday. The central bank is also expected to maintain its pledge to buy J-REITS at an annual pace of up to JPY180 billion.

The fact that the bank’s monetary policy guidance hinges on the 2% inflation target, a change in its ultra-dovish policy stance is unlikely to alter any time soon. Despite surging energy costs and resource prices causing Japan’s April consumer price index 
(CPI) to exceed the BOJ’s 2% price target for the first time since March 2015, may not be enough to convince the bank to act.

Rising pressure from the government to stem the yen’s fall, which is feeding into larger concerns for the Japanese importers and households, could prompt the BOJ to adjust its yield curve control (YCC) policy framework.

So far this week, the bank has spent about JPY3 trillion ($22 billion) in buying bonds across the yield curve to defend its cap of 0.25%. The BOJ’s efforts seemed to be of no avail, as the 10-year JGB futures plunged to levels last seen in 2014. The yield differential between the 10-year US and JGB widened to the highest since 2007.

Markets are expecting the bank to raise its yield cap to 0.50% from 0.25% under rising pressure from PM Fumio Kishida’s government. Kishida said on Wednesday, "while currency move is a huge issue, I expect the BOJ to take various effects into account” when asked if the central bank should adjust policy on Friday.

BOJ Governor Kuroda, however, is mindful of the risks of tweaking the YCC policy, as it would only accelerate the yen fall, which will inflate the cost of imports and hurt the economy.

Unless the increase in the yield target is accompanied by a strong intervention by the government to buy the yen, any adjustment to the yield cap will be self-defeating. It’s also worth noting that managing the exchange rate value is under the purview of Japan’s Ministry of Finance (MOF).

USD/JPY probable scenarios

Following the 75 bps rate hike by the Fed on Wednesday, the US dollar has pulled back sharply from its two-decade highs alongside the longer-dated yields. But the sentiment around the USD/JPY remains buoyed by the growing policy imbalance between the US and Japan.

A status-quo maintained by the BOJ and inaction on the FX front could trigger a fresh slump in the yen, which could see the pair head back towards 135.50 and beyond.

Any tweak in the YCC policy could offer a temporary reprieve to the yen, as it could imply the BOJ’s willingness to respond to the emerging crisis situation for the economy.

To conclude, USD/JPY remains a ‘buy the dip’ trade, as the policy contrast will continue to emerge as the main underlying factor weighing on the Japanese currency.