Tomorrow sees the meeting of the BOJ, followed next week by inflation figures. In somewhat unusual circumstances, the data coming out after the central bank meeting might have a bigger impact on the market.

There is a lot of scrutiny on the BOJ right now because the USDJPY is pushing into critical levels. The higher the pair goes, the more speculation rises that something could be done to bring it down, with the BOJ potentially taking the lead. This puts the yen in a unique situation among other major currencies, in that interest rates are not seen as the most immediate driver of the currency.

Here we are again?

Last year, the yen weakened considerably as the BOJ kept up its ultra easing policy, while other central banks tightened. Carry trades came back into vogue and the Japanese currency depreciated to the point that the government was forced to step in to stop the fall.

But the real correction happened when the BOJ widened the band on its YCC, effectively allowing monetary tightening. Since this was seen as the first step that would be needed to be taken in order for the BOJ to eventually start raising rates, the market reacted quite strongly. The yen strengthened for a few months, particularly as expectation grew that a new BOJ governor would usher in the end of the ultra-low rates.

Maintaining credibility

But the new governor, Kazuo Ueda, has not delivered on those expectations, and doubled down on the ultra low policy. Naturally, the yen has started to drift back towards its prior lows. Last week, the government started to express concern about weakness in the currency in an effort to “jawbone” some strength into it. But the recent moves in the USDJPY suggest that markets aren’t believing them this time.

The weakness in the yen is a particular problem for the BOJ, since it is seen as the main driver for the recent bounce in inflation. That’s because Japan imports a substantial amount of its goods, and a weaker yen would make exporting more attractive. Inflation has been coming down, just as Governor Ueda expected, but that relies on the yen getting stronger in that period. If the USDJPY were to make another run at the 150.00 handle, it could bring back inflation.

The BOJ vs the numbers

The BOJ is expected to keep policy exactly as it currently is, in line with repeated statements by officials that the ultra-low policy will be kept in place until a review is completed. Meanwhile, next week’s inflation reading is expected to show the annual pace falling to 3.2% from 3.5% prior. So far, the data matches the BOJ’s outlook and policy.

But, recent GDP figures showed that Japan is finally seeing growth, which could translate into the kind of “organic” inflation the BOJ wants to see. That could exacerbate the price inflation caused by a weaker currency, and speed up the need for the BOJ to at least start suggesting that the ultra-low rate policy will come to an end. Most traders don’t believe that could happen at the current meeting, but it’s an open question regarding just how much Ueda will let the currency weaken before hinting about tighter policy.

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