MNI INSIGHT: Weak Economy Ties BOJ To Easy Policy As Yen Sinks

The Bank of Japan is increasingly concerned that rapid yen depreciation will erode the confidence of firms and households, but the economy and outlook for inflation remain too weak for officials to consider moves away from easy policy which might bolster the currency, MNI understands.

The yen fell to 134 to the dollar on Wednesday, its weakest in more than two decades and compared to around 113 in January, increasing import costs and squeezing corporate profits. The JPY135.15 low from January 2002 is now in market sights. On Thursday, the yen traded around JPY134.36 and a morning high of JPY134.48.

The steep yen decline comes as major central banks outside Japan raise rates after a period of downplaying inflationary pressures, a mistake which BOJ officials would be keen to avoid. But market speculation of an adjustment to the upper bound of the yield curve control range in order to support the yen remains misplaced, given the continuing weakness of an economy still recovering from the Covid pandemic. (See MNI INSIGHT: BOJ Left With Jawboning As Yen Weakens)

Nor is the BOJ likely to consider altering guidance to remove the possibility that interest rates could be taken to “lower levels”, an adjustment expected by some foreign investors this year, given the risk that markets would misinterpret it as a move away from easy policy, potentially feeding downside risks.

Such a change to guidance could only come once officials see a positive output gap, solid wages growth and an outlook for sustained recovery and 2% inflation, with balanced risks. Instead, rising commodity prices, made more painful by yen depreciation, are set to prompt the BOJ to downgrade its view for the output gap to turn clearly positive by around the second half of fiscal 2022.

MUTED WAGE GROWTH

The central bank will review medium-term economic growth and inflation forecasts at its July 20-21 policy-setting meeting. While no monetary policy moves are likely then or at its June 16-17 meeting, officials will consider how to continue to support smaller firms once a special lending facility wraps up in September. The BOJ’s June Tankan business sentiment survey due on July 1 will be key in gauging how much small firms are being hit by dearer commodities.

But so far rising prices have not fed through into significant wage growth, and there is no sign of second-round effects which have pushed other major central banks towards tightening.

Instead higher prices may depress consumption, as processed food becomes more expensive, weighing on low-income households. While BOJ officials had expected consumption to be boosted by JPY50 trillion of forced savings accumulated during the pandemic when people were unable to go out to spend, equivalent to about 9% of gross domestic product, more than half of these funds are in the hands of high earners.

On Tuesday, BOJ Governor Haruhiko Kuroda felt obliged to apologise for commenting the day before that households were becoming more tolerant of price rises as firms increasingly look to recoup higher costs, which he had called an important step towards achieving sustained inflation.

Unlike in the U.S. and the eurozone, Japanese GDP has still to return to pre-pandemic levels, something the BOJ only expects by the third quarter, in line with the board’s median forecast for GDP to expand by 2.9% this fiscal year.