USD/JPY to price in further easing into 30 October

Nearly two months have passed since China's devaluation of the RMB began to put pressure on the Bank of Japan to ease monetary policy further. Although external, domestic economic, or inflation factors have not yet proved decisive, speculation for further easing has increased.

With regard to external conditions, risk-off JPY strength has been building since August, and the JPY's effective exchange rate is now within 2% of the level prior to the QQE expansion last October. The Fed left policy unchanged in September and the September US employment report disappointed. Global equity markets remain under pressure, contributing to funding currency strength, including the JPY. Asian production and trade indicators worsened markedly.

Domestically, Japan's growth data have disappointed to the downside over the summer, but BoJ Governor Haruhiko Kuroda points to the corporate sector and related strong Tankan results to justify his optimism about Japan's economy. In that regard, the September Tankan results were probably reassuring for the BoJ, notes Bank of America Merrill Lynch.

 As the BoJ has held, the trend inflation appears solid, even as market inflation expectations continue to fall. Worryingly, though, corporate inflation expectations were also lower than in the June Tankan survey.

"Overall, although various factors support the BoJ's optimistic outlook, JPY strength on risk aversion and JPY weakness on further easing appear to be offsetting. We think such conditions will hang over the BoJ's monetary policy meeting on 30 October. Although the options market continues to favor JPY strength, we think speculation for further easing could gain traction through end-October", says Bank of America Merrill Lynch.