MNI BOJ INSIGHT: North Korea-Induced Yen Rise Risk to 2% CPI

--BOJ Sees Greater Risk to Inflation Than to Growth From Yen Rise

By Hiroshi Inoue

     TOKYO (MNI) - The fact that there was only a modest rise in the yen

exchange rate amid heightened concerns about possible military conflict between

the United States and North Korea came as a relief to Bank of Japan officials,

as a stronger exchange rate poses a risk to the central bank's economic and

inflation goals.  

     But renewed safe-haven yen buying will remain a key risk for Japan.  

     A stronger yen could dampen domestic share prices as well as sentiment

among firms and households if it threatens exporter profits, job creation and

wage hikes. That could eventually undermine the economic expansion.

     However, BOJ officials are more worried that a yen rise would push down

import costs and consumer prices overall, in turn making it harder for the BOJ

to achieve its already elusive 2% inflation target.

     "Concerns over a stronger yen caused by geopolitical risks have eased

somewhat as financial markets are calmer but (BOJ officials) are keeping a close

eye on market developments," said a person familiar with BOJ thinking.

     "The tension between North Korea and the U.S. seems to have eased as their

leaders are reportedly making efforts to avoid an armed conflict. But this

geopolitical risk remains a primary focus for market players."

     The dollar stood around Y109.83 in Asia Thursday afternoon trading, after

falling to Y108.84 in New York Friday.

     The Nikkei 225 stock index closed at 19,702.63 Thursday, down 26.65, or

0.14%, from Wednesday. On Monday the index fell for a fourth straight day to a

three-month low of 19,537, down 0.98%. It picked up slightly on Tuesday but

slipped again in the following two days.

     North Korea leader Kim Jong-un has delayed a decision on firing missiles

towards the U.S. territory of Guam while he watches the actions of the U.S. a

while longer, the official North Korean news agency said.

     Last week, U.S. President Donald Trump warned Pyongyang that he would

unleash "fire and fury" if it further threatened the U.S.

     On Tuesday, Trump and Japanese Prime Minister Shinzo Abe agreed to work

together closely to prevent North Korea from firing off additional missiles. 

     If a renewed yen appreciation were to lower Japanese share prices, the BOJ

could buy more exchange-traded funds (ETFs) or increase its fund injections into

financial markets to support overall sentiment.

     Buoyant stock prices are a lifeline for the Abe administration, whose

public support has dropped this year due to a series of scandals.  Abe's

government has yet to deliver on its promise to completely overcome deflation

and achieve stable 2% inflation and has yet to fully implement politically

unpopular structural reforms needed to raise the economy's growth potential.

     "The impact of a stronger yen on inflation would be more severe than its

impact on the real economy," said another person familiar with BOJ thinking. "A

yen rise, depending on its pace, would not immediately worsen the foundation for

the current moderate economic expansion based on domestic demand." 

     He added that it would take time for a stronger yen to affect the economy

and that BOJ officials would need to judge the overall impact. 

     But once the yen appreciates, it would have a direct effect on consumer

prices, the person stressed. 

     On the positive side, a stronger yen would pave the way for the BOJ to

reduce further the size of its Japanese government bond purchases.

     On Wednesday, the drop in JGB yields caused by both the yen rise and

continued tight bond supply-demand conditions prompted the BOJ to reduce the

size of its JGB purchases with a remaining life of 5- to 10-years to Y440

billion per auction from Y470 billion.

     The cut in JGB buying, the first since July 24, was aimed at preventing the

10-year bond yield from falling further.  The 10-year bond yield fell to 0.040%

Wednesday, its lowest level since June 7.

     The BOJ wants to reduce the pace of its JGB purchases and thus reduce the

increase in its bond holdings without upsetting the bond market so that it can

eventually exit from aggressive easing in a smooth fashion.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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