MNI POLICY: BOJ Sees Yen's Direction Steered By Fed Outlook

Bank of Japan Governor Haruhiko Kuroda and his colleagues have no intention to tweak monetary policy to fight a weak yen, instead they intend waiting for a slowing in the Federal Reserve's aggressive rate hiking cycle later this year or early 2023, MNI understands.

The BOJ, which started a two day meeting on Thursday, views a change in the Fed's policy outlook as the remedy to a weak yen, which tumbled to a fresh 32-year low of around JPY152 against the U.S. dollar on October 21 amid widening interest rate differentials between Japan and the U.S. (See MNI BOJ WATCH: BOJ To Maintain Easy Policy, Forward Guidance). The Japanese government was believed to have intervened on Friday to support the yen, though it has not been officially confirmed.

Given the yen has weakened as the U.S. dollar has risen on higher U.S rates, the BOJ views a peaking - and eventual decline - in U.S. rates as likely to weaken the greenback. The BOJ is alert to the risk that a sharper-than-expected contraction in U.S. growth could spark global market volatility, which could lead to a rapid rise in the yen as a safe haven play.

BOJ officials assess the Fed will tolerate growth slowing to around 1% versus the potential growth rate of around 1.8%, which will create an output gap that will place downward pressure on prices.

Any reliance on a near-term change in the U.S. monetary policy outlook to curb yen weakness appears optimistic given the Fed has telegraphed that inflation remains its top priority given tightness in the labour market and wage growth, according to the BOJ's view. Officials are watching to see whether vacancies fall as interest rates rise otherwise wage gains will not slow and inflation will remain at high levels.

Additionally, US rent increases have peaked but will not immediately affect the CPI, keeping inflation at elevated levels as it takes time for rents to filter through to the CPI. (See MNI POLICY: BOJ Wary Of Slow China Recovery, Fed Hike Impact)

Japan’s government and the BOJ lack effective measures to stop the weak yen trend as yen-buying interventions are only effective in temporarily slowing the pace of the currency’s fall. That is why the outlook for U.S. monetary is being closed watched by the BOJ.

The Fed will continue its efforts to tame inflation at the expense of slower growth in order to ensure medium- to long-term inflation expectations don't climb above its 2% inflation target, according to the BOJ view.

The Fed will face a challenge of smoothly communicating with market players as the economy slows. The BOJ believes signs of easing US inflation need to be viewed as credible by the market, while being conscious the Fed needs to ensure that investors and traders don't start pricing in rate cuts too quickly, which may undo the inflation-dampening impact of earlier hikes.