JPY outlook looking beyond BOJ

USD/JPY has been consolidating between 118 and 122 after CNY-led market volatility subsided in the last week of August. With the Bank of Japan (BOJ) maintaining a neutral stance on its asset purchase program yesterday, the currency pair is likely to continue fluctuating around 120. 
 
"We are monitoring a divergence between the market and policymakers over the direction of monetary policy. Given the disappointing data coming out of Japan lately, the market believes that the BOJ may need to increase the expansion of its monetary base again. The target was last lifted in Oct 2014 to an annual pace of JPY 80 trillion from JPY 60 trillion after the economy entered into a technical recession following the first sales tax hike in Apr 2014," says DBS Bank research.

Conversely, PM Shinzo Abe and other policymakers have started to question the cost and benefit of relying heavily on monetary stimulus to achieve the 2% inflation target amidst slower emerging market economies and lower oil prices. Talk has emerged to introduce more flexibility, namely the time frame, to achieving the inflation target. With the yen having corrected its excessive strength over the past two years, and the real effective exchange rate weak, there are now demerits, not just benefits from further yen weakness.

"There appears to be a reluctance to further expand the monetary base target. If the yen is to weaken again, it will have to come from a stronger USD, especially against other Asian currencies. Hence, US rate hike expectations and CNY depreciation prospects will probably matter more going forward," added DBS Bank.