MNI POLICY: Fed Cut No Obstacle For BOJ Hiking Path

MNI (TOKYO) - The yen’s move lower following the Federal Reserve’s decision to cut its benchmark rate 50 basis points has comforted Bank of Japan officials concerned a stronger currency would scuttle its hiking plans, which potentially include quarterly 25bp hikes starting as early as December should fundamentals hold, while officials will also review market communications following July's increase that caught the market off guard, MNI understands.

While a stronger yen will theoretically weaken inflationary pressure and squeeze exporters’ profits, CPI may not slow by much if durable goods prices fail to drop in line with the rising import penetration ratio and pass-through of cost increases in services remain solid. Bank officials see a limited impact on inflation unless the currency moves rapidly towards JPY120. Otherwise, the BOJ will not abandon its rate hiking path to depreciate the currency as real interest rates remain low.

The Bank will move to raise the policy rate to 0.50% smoothly if economic and price conditions allow and the U.S. economy does not fall into serious recession.  (See MNI POLICY: BOJ Examines Upping Pace Of Hikes) However, it will take a more cautious approach lifting the rate towards 0.75% as Japan has not experienced rates above 0.5% since 1995.

The yen weakened to about JPY143.7 against the U.S. dollar from 142.1 following the Fed cut. A stronger currency and volatile financial markets remain the most significant risks to the BOJ’s strategy as the Fed enters its easing cycle.

While the Bank will not pre-emptively flag a policy decision, officials are reviewing its market communications following the surprise over July’s hike, which they believe was driven by misunderstood BOJ messaging. 

YEN OUTLOOK

Bank officials will monitor the yen’s strength during the Fed’s easing cycle and gauge its impact on the equity market, and exporters’ profits, which could impede wage hikes next year. A slower U.S. economy could accelerate Fed cuts, which will strengthen the yen and exacerbate financial-market volatility.

While Fed communications stressed a cautious approach to cuts, Chair Jerome Powell said Wednesday more rapid easing could occur if the economy weakens unexpectedly.

Policymakers will scrutinise whether economic and financial conditions warrant an additional rate hike at the December meeting after examining evolving markets and inflation, including the October price revisions and their impact on consumption.

FRIDAY MEETING

Policymakers are likely to keep the policy interest rate at 0.25% on Friday following the conclusion of the board’s two-day meeting, while Governor Kazuo Ueda is expected to repeat his stance that policy adjustment will continue should the economy and prices move in line with the Bank’s forecast. (See MNI BOJ WATCH: Board To Hold, Examine Economy, Price Risks)

However, Ueda will likely downplay an imminent rate hike on the back of nervous and volatile financial markets, although he may not rule out a December increase.

BOJ overnight index swaps have priced in a 25% chance of a hike at the Dec 19 meeting to 0.30%, unchanged following the Fed’s move.