The Bank of Japan (BoJ) was the last monetary authority to abandon negative interest rates. It has also stopped buying ETFs and has discarded yield curve control. After 22 months of inflation above the 2% target and with wage growth approaching 5% for the first time in 33 years, the central bank is confident that deflation has been vanquished.
As the BoJ unwinds its ultra-lose monetary policies, the rest of the developed countries are expected to move in the opposite direction sometime this year. Does this mean the yen is set to rise? Not necessarily. The Bank of Japan has been careful not to give guidance on possible future interest hikes and has insisted that it will be maintaining an accommodative posture as it continues to buy the same amount of government bonds per month to keep long-term rates under control. The problem is that there are many risks in increasing rates too quickly. First, inflation could ease, and the monetary authority does not want to have to retrace its steps and lower rates again. Second, as interest rates rise, interest payments on the large public debt will increase, putting pressure on public finances. Higher rates will also pose a problem for consumers and enterprises used to ultra-low rates.
More importantly for the yen, there is still a significant difference between Japanese interest rates and those of the rest of the developed countries. It is this interest rate gap that is at the core of the yen carry trade. Investors will still find it interesting to borrow yen, invest the proceeds in higher-yielding currencies and make easy money. So, although we do not expect the yen to depreciate much from current levels for fear of intervention to defend the currency, nor do we see it appreciating much until the BoJ indicates a more hawkish stance.
Date of report: April 10th 2024