Bank of Japan Decision Forecast: Ultra-loose policy expected to remain unchanged even as pressure mounts

• The Bank of Japan will once again keep interest rates and yield curve control policy stable.
• The Bank of Japan is said to improve inflation forecasts for fiscal years 2023 and 2024.
• Quarterly outlook will overshadow Japan’s interest rate decision, shaking USD/JPY.

The Bank of Japan (BoJ) is expected to announce its interest rate decision, as well as the yield curve control (YCC) policy, on Tuesday.
Ahead of the BoJ’s policy announcements, the Japanese Yen (JPY) has regained some ground against the US Dollar (USD), having weakened beyond the key 150.00 level last week, a threshold that once again boosted Japanese authorities to intervene in the bond market.

Markets are not expecting any surprises from the Bank of Japan, even though the country’s inflation exceeded the 2% target for the 19th consecutive month and government bond (JGB) yields remained at decade highs.

Bank of Japan policy expectations and their impact on USD/JPY

Following the October monetary policy review meeting on Tuesday, the Bank of Japan will leave its current policy unchanged, keeping the 10-year JGB interest rate and yield target at -10 basis points and 0.00%, respectively.

Ahead of the BoJ’s policy announcements, the central bank has already intervened in the bond market for the sixth time this month to curb the relentless rise in JGB yields. Domestic yields have buckled under upward pressure, induced by the stunning rally in US Treasury yields to a 16-year high. The yield on the benchmark 10-year US Treasury bond briefly surpassed the key 5.0% level last Monday.

The benchmark 10-year JGB yield stands near 0.86%, its highest level since July 2013. The persistent rise in JGB yields has put pressure on the BoJ “to discuss the possibility of further easing of the YCC in the October policy meeting,” Reuters reported, citing central bank sources. The Bank of Japan unexpectedly raised the 10-year yield cap from 0.50% to 1.0% on July 28.

Another concern for the Japanese central bank remains the high level of inflation, which has been consistently above the 2% target for more than a year. Tokyo’s core Consumer Price Index (CPI), a figure closely watched by the Bank of Japan, rose 2.7% in October from a year earlier, up from a 2.5% rise in September. Meanwhile, the “core” index, which excludes fresh food and energy, rose 3.8%.

Amid persistently high inflation, three people familiar with the matter said earlier this month that “the Bank of Japan is set to raise its forecast for core consumer inflation for the year ending March 2024 to around 3.0.” % from the current 2.5% projected in July in its new quarterly growth and inflation forecasts report. It is also expected to improve its forecast for 2024 from the current 1.9% to 2.0% or more,” Reuters reported.

BBH analysts noted: “Updated macroeconomic forecasts will be key. Reports suggest that the Bank of Japan will likely revise its core inflation forecasts upwards at this meeting. The forecast for fiscal 2023 will likely be closer to 3.0% versus 2.5% seen in July, while the forecast for fiscal 2024 will likely be 2.0% or higher versus 1.9% seen in July. Forecasts for fiscal years 2024 and 2025 will be very important, as anything well above 2% would suggest that the bank will likely begin removing accommodative policy in early 2024.”

A possible upgrade to its inflation estimates would still allow the BoJ to maintain its ultra-loose monetary policy stance. However, it would also mean increasing pressure on the central bank to raise its yield cap beyond the current 1.0%.

That said, the Bank of Japan could hold back as policymakers continue to evaluate various factors to take into account when abandoning ultra-loose policy while patiently waiting for a sustainable achievement of the target. According to a summary of views from the BoJ’s September meeting, a board member said the second half of the current fiscal year, which ends in March 2024, will be an “important period” in determining whether the BoJ price target will be met. Boxwood.

Economists polled by Reuters showed that almost 80% of them expect the Bank of Japan to abandon the 10-year yield control framework by the end of 2024. Most of them predicted that the central bank would end its rate policy negative interest rates (NIRP) next year.

USD/JPY Technical Outlook

If the Bank of Japan raises the yield target or improves inflation projections, it could signal that the central bank is preparing to change course toward aggressive policy sooner than expected. In such a case, the Yen is likely to experience a strong wave of buying, triggering a notable sell-off in USD/JPY. Conversely, BoJ inaction on policy and outlook will see USD/JPY return to last year’s FX intervention level of 151.96.

Dhwani Mehta, chief analyst for FXStreet’s Asian session, offers a brief technical outlook for the pair and explains: “The USD/JPY pair is holding on to the critical 21-day SMA at 149.52 in the run-up to the Bank of Japan Decision. The 14-day Relative Strength Index (RSI) remains comfortably above the 50 level, keeping upside risks for the pair intact.
On the upside, immediate resistance lies at 150.42, Friday’s high, above which the previous week’s intervention level of 150.78 will be retested. Alternatively, a sustained break of the 21-day SMA could trigger a fresh decline towards the ascending 50-day SMA at 148.25. The last line of defense for buyers will be the round figure of 148.00,” Dhwani added.