When Bank of Japan’s Governor Kazuo Ueda announced a rate hike of 25 basis points last week, it is hard to believe he expected things would turn out the way they did: The Japanese yen appreciated by nearly 5% against the US dollar, and the Nikkei 225 had its worse day since 1987 crashing by 12.4%, before bouncing back the next day. However, this high market volatility and yen appreciation have questioned the BOJ’s plans for the rest of the year, putting into question the progress of the yen moving forward.
Following the BOJ’s meeting from last week, Ueda kept the door open to another rate hike year of 25 bp. The BOJ’s short-term policy rate is still low at 0.25%. This news, while expected, still pushed the yen to nearly 150 against the USD. The BOJ kept claiming that the recent rate hikes were mainly related to the bank’s desire to combat inflationary pressures. While inflation in Japan is currently at 2.8%, above the BOJ’s target of 2%, the recent yen appreciation could put downward pressure on imported inflation, thus reducing the need for additional rate hikes.
Japanese officials appeared more concerned over the weakness of the Japanese yen rather than taming inflation; indeed, Japan’s Ministry of Finance intervened in the currency market to shore up the yen by spending 5.53 trillion yen or $36.8 billion in July, even though the efficiency of these efforts in boosting the yen is unclear.
However, recent developments from the US put more pressure on the yen and could revise the BOJ’s future path of interest rates. Friday’s US jobs report showed unemployment climbing to 4.3% – 0.2 basis point rise –triggering the Sahm rule, indicating a US recession could become more likely. The Federal Reserve did not lower rates in its July meeting, but it is expected to cut rates in September and will have four to five 25 bp cuts this year. Besides the rally in the yen, Japanese stock markets such as Nikkei 225 and Topix crashed on Monday; since a significant portion of the firms trading there are exporters, this news could harm the Japanese economy.
Besides raising rates in March, the BOJ also eliminated other stimulative monetary policies such as Yield Curve Control and the ETF purchase programs. The latter was aimed to boost Japanese share prices, which, in turn, should have improved the economic conditions; however, as I showed in a recent paper, its contribution to the Japanese economy was a mixed bag, and exiting the program left the stock market in a vulnerable spot with no support from the BOJ.
The BOJ just ended some of its ultra-loose policy programs and is not expected to flip-flop and bring them back so soon. Hence, the likely course will be a wait-and-see approach, leaving rates unchanged this year. The more likely move that will affect the yen is the Fed’s actions. However, I do not see the FOMC convening in an emergency meeting to slash rates, even if markets keep falling (as long as there is no rerun of 2020). The more likely scenario will be a 25-50 bp rate cut in September; if the Fed were to align its rate path outlook with the current market expectation, it could mean further strengthening for the yen, but given the Fed has been slow to move, I doubt we will see the Fed keeping up with current market expectation and may only resort to a 25 bp cuts every meeting – especially given the sharp decline in long-term treasury yields and if market volatility were to calm down by September. If the Fed were to move slower than expected, this could curb the recovery of the yen, but probably not enough to prompt another rate hike by the BOJ anytime soon.
For further reading see
The effects of the BoJ’s ETF purchases on equities and corporate investment
