BoJ Meeting and Outlook Preview

The last meeting held by the Bank of Japan (BoJ) was a certainly a historic one. The BoJ ended the era of negative interest rates, after 8 years!

The decision came after a 7-2 majority vote to raise the overnight interest rate to 0% - 0.1% from a previous negative level of -0.1%. They also discontinued Yield Curve Control (YCC) and stopped purchases of ETFs and REITs.

We certainly don’t expect another hike at tomorrow’s meeting but we think that there may be changes to the outlook and a more hawkish rhetoric to control the depreciation of the Japanese Yen.

Recent PMI data may set the groundwork

Japan’s PMIs came out better than expected this week, with the Composite and Services Index firmly in expansionary territory. This could mean news for inflation and growth.

Weak GDP growth has been weighing on the macro outlook and with this there are some signs that we may see improvement in the months to come. More often than not, the PMI leads to GDP growth.

Input and Output prices both showed stronger inflation and output & new orders showed improvement. Employment showed stronger growth as well.

BoJ Outlook Preview

The BoJ meeting tomorrow comes with their Economic Outlook Projections. The last Outlook saw the Bank reduce their forecasts for inflation.

However, with stronger expectations of wage growth after the Shunto Spring Negotiations, and the recent improvement in PMI data, we may see the BoJ increase their inflation estimates for 2024 and 2025. This would definitely signal that the BoJ is accepting the inflation trajectory higher and may start to adopt a hawkish view. This could help strengthen the JPY.

The risk to this forecast, however, remains the latest inflation numbers that actually came in lower. Japan has been contending with years on deflation and now that the country is experiencing inflation again, they want to make sure it takes hold.

But inflation has largely been driven by external factors, a weaker Yen and imports. So the BoJ has been waiting to hike until inflation is driven by wage growth and consumption.

Nevertheless, real wages & real consumption growth still remain negative and this could keep the BoJ from hiking again until they see further evidence of inflation taking hold.

Currency in Focus

Despite the hike during the last meeting, the Japanese yen has only weakened, no thanks to a very strong dollar. While the hike in Japan ended negative interest rates, comparatively rates still remain at severely low levels.

Furthermore, the BoJ announced that conditions would continue to remain easy with bond purchases and this helped the fuel buying in equities and has kept the JPY weak. In one way, this is helpful because it makes sure that inflation continues to be imported but, now the currency has reached extremely undervalued levels.

The REER (Real Effective Exchange Rate) highlights the growing need for the Bank of Japan to adjust its extremely lenient monetary policy, which has been suppressing the country's interest rates and devaluing its currency.

Key Takeaway

Tomorrow’s BoJ meeting could see a more hawkish tone from the BoJ, if for no other reason than to help the JPY strengthen. The BoJ could adjust the inflation outlook higher, and discuss tapering of bond purchases, although they have committed to keeping policy easy even last week.

However, a hawkish tilt could put pressure on Japanese equities, and push up JGB yields.

We’ve also seen this situation weigh on the US Equity markets and push up US yields, and that’s something to look out for particularly now that we’re already seeing “higher for longer” remain front & center in the US.