Bank of Japan is likely to stay on hold - for now...

Comments from Gregor MA Hirt , Global CIO Multi Asset, ahead of the Bank of Japan meeting on 30-31 October 2023

• We expect the Bank of Japan (BOJ) to keep its policy unchanged at next week’s meeting. While pressures are increasing and there is an elevated risk of a surprise, we think the BOJ is inclined to await additional data until the next meeting before the end of the year.
• Inflation remains at elevated levels and has exceeded expectations; even as tentative signs of deceleration begin to set in; more confirmation on wage data is needed.
• Updated economic projections are released at this meeting. There is a reasonable probability that the Japan-style core inflation forecasts for FY2024 will be upgraded to 2%, at which point markets might see a stronger case for upcoming policy adjustments. ?

Inflation trends have begun to level off. The BOJ’s preferred measurement parameter (CPI ex. fresh food, energy) decelerated from 4.3% to 4.2% year-on-year for September[1], which was a slower decline than market participants had expected. The BOJ’s outlook report is released, and we anticipate further upgrades to the BOJ’s own CPI projections. Despite arguably excessive easing, detrimental Japanese yen weakness and a ballooning BOJ balance sheet, we do not expect a change at this meeting.

For the BOJ to enact policy adjustments, it needs to gain confidence that wage improvements have become sufficiently entrenched.

We expect the BOJ to await additional data points until the end of the year.

In October 2023, the Japanese Trade Union Federation (RENGO) proposed a “5% or more” target for the 2024 spring wage negotiations (Shunto), surpassing the 2023 target of “around 5%”. This could indicate sustained wage pressures, aligning with the BOJ objectives. Additional relevant data on corporate earnings, the output gap and aggregate earnings estimates only become available until the December meeting.

The BOJ recently has shown a pattern to move ahead of market expectations. Many market participants expect policy adjustments in H1 2024. We thus think an early move at the December meeting could be possible, but the October meeting next week appears premature to us, as the BOJ also assesses the impact of rising global yields. A possible move could be a further widening of the yield curve control (YCC) band, a removal of the 0.5% reference point or a change in how the daily bond buying is conducted. ?

In terms of positioning, we remain cautious on Japanese Government Bonds and moderately constructive on the Japanese yen. Despite the 10-year yield approaching the 1%-YCC limit, the eventual removal of YCC and higher yields remain our base case. The situation is more intricate for the JPY. Without substantial policy changes by the Fed or the BOJ, a significant reversal lacks catalysts. However, given extreme undervaluation and possibly narrowing policy differentials in 2024, we see room for modest JPY strength. There is also some optionality for a more sustained move in case of a policy surprise. At the same time, the Japanese Ministry of Finance would likely try to limit the downside to some extent, even as the effectiveness of its tool kit is limited in the current environment.

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[AM 3191370]

[1] Consumer Price Index Japan, The Statistics Bureau and the Director-General for Policy Planning of Japan, 20 October 2023