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Japanese Yen’s Trend against US Dollar Hangs on BOJ Rate Decision

The Bank of Japan is widely expected to keep interest rates on hold at 0.10%, but currency traders will be focused on the future of the central bank’s emergency lending measures, whose near-term fate will hint the direction of the Japanese Yen’s long-term trend against the US Dollar.

Bank of Japan Strikes Hawkish Stance on Lending Programs

BOJ Governor Maasaki Shirakawa and company have upgraded their outlook for the world’s second-largest economy at several consecutive policy meetings over recent months, and minutes from the latest policy meeting in September revealed a lively discussion about “exit strategies” for temporary credit-boosting schemes. On balance, most BOJ members seemed eager to pull back some of these programs, concluding that their fate “should be decided appropriately in light of the degree of improvement in financial conditions” which most agreed were increasingly on the mend. A few policymakers even went so far as to suggests that the positive impact from the bank’s lending facilities was “on the wane”, noting a decline in the Bank’ asset purchases and relative stability in overnight borrowing costs. All told, the climate on the BOJ’s policy board seems to lean towards an announcement that their support for corporate finance is on its way out.

Ministry of Finance: An Agenda of Their Own

The view from the Ministry of Finance (MOF) is quite different from that of the BOJ however: Finance Minister Hirohisa Fujii has been vocal about his position that the central bank’s outlook is too optimistic and ill-informed, trying to pressure the monetary authority to keep in place its asset-buying programs. An un-sourced report from Nikkei News suggested this week that the government and the BOJ may start holding monthly meetings to “exchange views” on the economy and financial conditions, hinting that perhaps the government is trying to muscle in on the central bank’s independence over monetary policy.

This kind of activism seems linked to investors’ concerns about how Japan plans to deal with its ballooning public deficit, the largest in the developed world. The worry is that a massive issuance will flood the market and collapse the price of government debt all the while sending borrowing costs higher and derailing the economic recovery. Both Prime Minister Yukio Hotoyama and Fujii have been on the wires in recent days talking up fiscal discipline, with the former saying that lawmakers will be able to “secure the trust of the Japanese government bond market” and the latter saying that the size of future bond sales will be critical to the latest budget’s composition. Naturally, the MOF would not be as concerned about issuing debt if the Bank of Japan continued to be an active buyer of it, keeping prices supported and yields in check. To that effect, the government is keenly interested in how the BOJ proceeds from here.

Trading the BOJ Interest Rate Decision

Currency traders will be faced with one of three possible outcomes as the Bank of Japan announces monetary policy. The central bank may openly say that it plans to end its support for corporate finance and let its credit-boosting programs expire in December. In this scenario, it will be clear that the monetary authority will not serve to mute the impact of government’s efforts to fund the deficit, signaling that Japanese yields may be setting up to move higher. This outcome likely points to a decline in USDJPY: the currency pair is over 83% correlated with the yield on 10-year US Treasury bonds, reflecting Japanese investors’ appetite for dollar-denominated assets offering safety and liquidity with higher returns than they can get on domestic paper. Higher yields at home will make these assets less attractive by comparison, boosting the Yen against the greenback.



Naturally, the opposite will likely be the case if policymakers commit to keep the programs in place or even extend them, cosigning the government’s position. In this case, investors will expect Japanese yields to be relatively contained as the central bank continues buying public debt instruments, shaping expectations that returns on USD-denominated assets will be more attractive and driving USDJPY higher.

Finally, the BOJ could continue to say nothing concrete and stall on the matter of the special lending programs yet again, making the announcement itself a non-event and delaying the potential for volatility for the when the minutes of the meeting are released at a later date and offer detailed insight on the level of discussion that took place ahead of the rate decision between central bank and government officials (who are present and do offer their position during monetary policy meetings).


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