Japanese Yen Slides Ahead of BoJ While Chinese Data was Digested. Where to

The Japanese yen has seen an unimaginable depreciation over the past year. This is largely because of the widening gap between the yen’s and the US dollar’s interest rates. As a result, yen prices are falling faster than they were a year ago, which is creating uncertainty for Japanese companies. It is also raising the cost of imported goods, which is bad for the economy.

Earlier this week, the yen faced heavy selling pressure. Its exchange rate dropped to a 32-year low against the dollar, and has since stabilized at a lower level. However, the Bank of Japan (BOJ) is maintaining its ultralow rate policy despite the sharp yen decline.

Yesterday, the Bank of Japan held its first monetary policy meeting of the year, keeping short-term interest rates at zero percent. The bank maintained its pledge to achieve inflation target “as soon as possible” and reiterated its pledge to keep long-term yields at an ultra-low rate.

In the wake of its policy decision, the yen retreated to its lowest level in nearly eight months. Meanwhile, the Nikkei 225 equity index climbed to a more than four-year high. With investors hopeful that the BOJ will ease monetary policy to support the yen, the dollar gained ground against the yen. While the yen exchange rate declined, the dollar held steady in European trading.

Although the BOJ maintains a dovish stance, it is facing a daunting task in justifying its dovish tilt. Many countries are hiking interest rates as global monetary tightening continues. One example of heavy-hitting central banks raising interest rates is the United States Federal Reserve. Another is the Bank of England.

The BOJ’s ultralow rate policy is meant to support a slow economic recovery and to provide robust wage growth. Japan’s main inflation target is 2 percent, and it is expected to reach that goal by the end of the fiscal year. But, with a headline inflation rate that has remained above this threshold for five months in a row, it is a stretch to see this target met.

The BOJ is aiming to keep the 10-year Japanese government bond yields around zero. The BoJ will also continue its large-scale bond purchases. If the currency continues to weaken, the government may have to intervene.

The BoJ has been a staunch defender of its ultralow monetary policy. But, if it decides to alter it, it will need to do so quickly. Even if the BoJ decides not to alter its policy, the yen will remain a headwind for the dollar.

The BoJ is expected to keep its ultralow rate policy unchanged at its March monetary policy meeting, though some markets are already pricing in a 25-basis-point hike in February. After the change of leadership, expect a shift in the Bank of Japan’s monetary policy in April.

If the yen continues to fall, it could trigger a ministry of finance intervention. But, if the market is not worried about the currency’s yen, it is unlikely that the government will intervene.