On October 30, the Bank of Japan will announce monetary policy as well as release its semiannual Outlook for Economic Activity and Prices. We anticipate that the report will show a reduction in inflation forecasts which underscores the fact that the BoJ is struggling to achieve its 1% inflation target. Expectations are that the Bank will miss this target as far out as 2014. Therefore, we expect the Bank to respond with more stimulus in the form of yet another increase to the Asset Purchase Program (APP). The APP currently stands at ¥80T and markets have been speculating increases of between ¥10-20T in additional purchases.
The economy may have fallen back into contraction in Q3 as incoming data has been weak. Consumer spending has declined, and exports dropped significantly. As Japan is heavily reliant on exports, measures taken by the Bank to weaken the yen would be beneficial on the margin. However, the strength of the currency is only one factor that is weighing on the export driven economy. Geopolitical tensions and slowing global growth as a result of increased uncertainties have reduced demand for Japanese exports. A drop in economic activity will weigh on prices which have been indicating deflation for some time. On Friday, Japan’s consumer price data showed national CPI falling by -0.3% y/y in September on the headline print while CPI excluding fresh food fell -0.1% y/y. More timely Tokyo price readings also showed deflation persisted in October.
The BoJ has been faced with increased pressure to ease further from the government. Economy Minister Maehara, who sat at the BoJ meeting earlier this month, said that he wants the Bank to pursue easing to achieve its price goal and also indicated that he may attend next week’s meeting.
The JPY was mostly softer earlier this past week after weak fundamental data and ahead of the BoJ meeting. Friday a reversal of yen weakness after the government proposed new fiscal stimulus and after better than expected CPI figures (however the numbers continued to show deflation as previously noted). With the potential for further easing from the BoJ, there is scope for JPY weakness heading into the meeting and even a knee jerk reaction lower in the yen following the announcement should the Bank take on additional measures. In the long run, we would prefer to fade yen weakness as increases to the Bank’s APP have not had lasting impacts on the exchange rate.
In fact, at the September 19 meeting when the BoJ last expanded stimulus by ¥10T, USD/JPY actually declined on the session. The Bank not only increased the amount of purchases then but also the length of the program which resulted in a slower pace of buying. It is likely that the Bank may make adjustments to the program to take a more aggressive stance to providing monetary easing.
The 200-day simple moving average (SMA) remains the key pivot and is currently acting as support. The daily Tenkan line also converges with the 200-day SMA around the 79.50 level. A break below here is likely to see USD/JPY move back towards the bottom end of its recent range. To the upside, the 80.50 level is key resistance and a close above is needed for gains to extend. While BoJ action may result in short term yen weakness, we doubt that USD/JPY upside can last without support from higher US treasury yields.