MNI INSIGHT: BOJ Hit By Yen Rise Worry, Limited Policy Options

By Hiroshi Inoue

     TOKYO (MNI) - The Bank of Japan is becoming more unnerved that a stronger

currency and falling stocks will weigh on both corporate and household

sentiment, reverse the virtuous cycle from profits to spending and undermine

momentum towards hitting the 2% inflation target, with growing concern over its

options to curb yen gains, MNI understands.

     The BOJ maintains the view for now that the cycle is still in place, but

believes prolonged weak global demand and volatile financial markets will affect

manufacturers sentiment, eventually filtering through to non-manufacturers and

domestic demand.

     The rising yen is the BOJ's main concern, as officials believe they are

running out of tools to effectively cap gains and its is eyeing the U.S. Federal

Reserve and whether it moves to cut rates again in September - a move which

could further strengthen the yen.

     -- Y100 CRUCIAL

     The BOJ accepts heightened downside risks to both activity and prices, but

sees no need for imminent policy easing as domestic demand remains solid,

although they are aware yen strengthening as global trade disputes build will

hit firms' and households' sentiment, impeding their spending.

     Options open to the BOJ to stall yen strength if needed are limited. One

route open is to cut the short-term policy rate form its current -0.1%, but bank

officials are cognisant of the side effects, including a further squeeze on

banks' profits and a destabilization of the financial system.

     The dollar traded at around Y106.20 in Tokyo on Tuesday after falling to

Y104.40 on Aug. 26 -- the lowest level in seven months. Any signs of sharp

appreciation towards Y100 will likely trigger pre-emptive BOJ action, as they

would see it as a significant risk to momentum towards its price target.

     --JGB YIELDS

     The BOJ is also on edge over benchmark 10-year JGB yields, which have

fallen to 3-year lows and are trading below the lower end of the bank's

tolerated trading range of -0.20% and +0.20%. The yield was last trading at

-0.27%, having dipped to -0.292% on Aug 29.

     Although the central bank accepts falling yields are largely in line with

global bond markets and growing economic risks, it is concerned questions will

growing over its control, of the yield curve - a central pillar of monetary

policy.

     Alongside yen concerns, the BOJ would also like to see the fall in JGB

yields curbed, but any reduction in size of its own bond buying operations to

push yields higher could lead to a strengthening of the yen. There is little

else open as policy option. It could widen the range of its tolerated 10-year

yields to -0.3% to +0.3%, but that could give the impression markets and not the

BOJ are in control of the yield curve.

     With data likely to be mixed at best over coming months, the BOJ faces

growing challenges when discussing additional easy policy at its September 18-19

meeting, with some board members already outlining the need for pre-emptive

action back in July.

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

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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