JPY to remain under appreciation pressure; BoJ unlikely to reach its inflation target in near-term

The Japanese yen is expected to remain under appreciation pressure in the near term as the Bank of Japan fuelled high expectations of its meeting this coming Wednesday. However, it remains highly unlikely that it will be able to convince market participants to reach its inflation target anytime soon.

The Bank of Japan (BoJ) had promised a comprehensive assessment of its monetary policy for this Wednesday’s meeting. Over the past few days and weeks, there has been a lot of speculation about what the BoJ might decide. The expectations differ widely in some respects. While some expect hardly any or no changes at all to its monetary policy, others speculate that the BoJ will lower interest rates on banks’ current account balances further into negative territory and/or extend its bond purchasing programme (QQE).

Moreover, there was speculation recently that the BoJ was mainly planning to lower interest rates at the short end rather than the longer end of the curve. Since the introduction of negative interest rates in mid-February interest rates at the ultra-long end of the curve (10-40 years) fell so considerably that the interest rate curve has flattened notably.

According to BoJ Governor Haruhiko Kuroda, this has important implications for the effectiveness of monetary policy: first of all low long term interest rates would cut yields for pension and insurance investments which in turn was putting pressure on corporate profits. Moreover the flat yield curve was putting pressure on the margins and thus the profitability of financial institutions.

Against this background, the BoJ may decide next Wednesday to conduct its bond purchases in a more flexible manner. At present it is aiming for an average (residual) maturity of 7-12 years. If it abandons these maturity requirements it could concentrate bond purchases at the short end thus steepening the rate curve again.

"We do not exclude that JPY would initially depreciate as a result. We however, see a risk that JPY appreciation will accelerate following Wednesday’s meeting," Commerzbank commented in a recent research note.