Assessing the Impact of Japan’s CPI on the BoJ’s Policy Stance

The recent weakening of the US dollar has provided a lifeline to the Japanese yen, allowing it to reclaim some of the grounds it had previously lost. As the currency landscape shifts, attention has now squarely focused on Japan's Consumer Price Index (CPI) numbers. Financial market participants are eagerly speculating over the implications for the Bank of Japan's (BoJ's) monetary policy direction, particularly amidst rising inflation rates. If the inflationary trend continues to gain momentum, there is potential for an expedited policy shift by the BoJ. The pivotal CPI data is set to be released on Thursday, at 23:30 GMT.

Japan's Phased Exit from Ultra-Loose Monetary Policy

In a recent move, the BoJ policymakers chose to fine-tune their yield curve control (YCC) mechanism, now permitting 10-year Japanese government bond (JGB) yields to go beyond the 1% threshold, yet refraining from abolishing the yield cap entirely. Instead, the cap was repositioned as a more flexible boundary, opening the door for strategic intervention in the bond market if seen as necessary by officials. This action reflected that although there's a shift away from ultra-loose monetary policy, the process could extend longer than financial markets had initially expected. Consequently, the yen's value stumbled, even nearing its October 2022 high against the dollar on November 13.

The Yen's Momentary Respite

Despite Japan's Gross Domestic Product (GDP) contracting more than expected in Q3—an event that complicates the BoJ's pathway toward policy normalization—the yen has seen some respite. This pause in the yen's decline is chiefly attributed to an overall weakening of the dollar and a dip in US Treasury yields, sparked by the US CPI figures coming in lower than anticipated. These developments altered market expectations, with investors now considering the possibility of interest rate cuts from the Federal Reserve in the upcoming year.

Fueling Wage Increase Prospects

The forthcoming inflation data from Japan for October is thus of significant importance. It may possibly hint at the BoJ's readiness to leave behind its YCC strategy and potentially move away from negative interest rates. Although exact predictions for the headline inflation rate are not yet available, the core CPI is expected to increase to 3.0% from 2.8%. With Tokyo's CPI also evidencing a rise, from 2.8% to 3.3%, there are clear signs that inflation is accelerating. This inflationary uptick enhances the chance for more robust wage increases, a significant factor as Japan's largest industrial union expressed their aim for a 6% wage uplift during the upcoming spring negotiations.

Supporting a Policy Shift

Successive significant wage increases could set the stage for the BoJ to exit its current, extremely accommodative monetary stance earlier than some have forecasted. Speculative thoughts about this possibility may support the yen's strength. Should the BoJ actually conclude its YCC approach and raise interest rates at a moment when other central banks are contemplating rate decreases, the yen might be well-positioned to make a strong comeback against major currencies, buoyed by rallying JGB yields as compared to falling yields elsewhere.

Anticipating the Yen's Trajectory

The dollar against yen pairing has witnessed a steep downward trajectory since its nearly 32-year peak. Nevertheless, it hovers above certain technical support levels. For a true bear trend to be recognized, the pair would need to breach these levels, which might steer it towards lower zones. Conversely, a resumption of the uptrend would be contingent on the pair exceeding the previous high, a scenario that could unfold if the BoJ underwhelms markets with persistent dovishness.

yen, CPI, BoJ, policy, inflation, shift, timing