Yen gains over dollar amid anticipation of BoJ policy change

The Japanese yen nearly reached a seven-month high against the U.S. dollar on Tuesday as investors anticipated potential policy change by the Bank of Japan. Data showed that the yen traded at 127.22 per dollar in Asia before falling lightly to 129.10.

This increase followed last week’s upward trend, in which the Japanese currency posted a three percent weekly gain against the greenback. The volatility level for the dollar/yen also hit the highest level since March 2020 last week. Overall, the U.S. dollar fell by approximately 14 percent over the previous three months against the yen.

Analysts predicted that the Japanese central bank would modify or even end its yield curve control policy because it was not sustainable. The market pushed the Japanese 10-year Treasury yields above the upper line set by the BoJ, which is 0.5 percent, on Friday and Monday.

The central bank tried to control the sharp surge by purchasing bonds from the market. Nikkei said the BoJ bought more than $15.6 billion in JGB yields on Monday. However, in the long run, the bank will run out of funds to keep the Treasury yields at a manageable rate.

Despite weakening against the yen, the U.S. dollar index showed a slight gain to 102.52 after hitting a seven-month low in the previous trading day. The euro gained over the dollar to trade momentarily at $1.0874 before falling. The U.K. sterling also saw a growth to $1.2288 during the session before falling slightly to trade at $1.2192.

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Possible policy change by BoJ

Last December, the Japanese government announced the extension of its 10-year bond yield range, which was originally at 0.25 percent. The central bank decided to implement this new policy as it maintained the low benchmark interest rates even if other central banks had consecutively increased their rates.

The extension of the bond yield range propelled the growth of the yen, which previously suffered from a continuous drop, especially against the stronger dollar at that time. The Japanese government even intervened in the forex market at one point to support its currency.

BoJ officials are due to attend a two-day policy meeting this week, in which analysts expect them to discuss possible policy revisions. Bank of America Global Research said the BoJ would likely maintain its 0.1 percent benchmark interest rate while scrapping the bond yield extension altogether.

BofA’s report also suggested that most Japanese investors thought the BoJ would reverse its policy. While the policy reversal will improve the stock market, it can also lead to a sharp decline.

“In our main risk scenario where the BoJ scraps YCC, we think that TOPIX could decline up to 3% in the near term, with key rate-sensitive sectors, such as banks, potentially outperforming,” the BofA report reads.

Takeshi Yamaguchi, Japan chief economist at Morgan Stanley, agreed with the possibility of the BoJ reversing its December policy so soon. Yamaguchi explained that the bond market was difficult to predict, meaning that policy reversal was more probable than a revision.

On the other hand, HSBC predicted that the BoJ would instead announce a further extension of the bond yield range to 0.75 percent. The extension may become effective within Q1 before Governor Haruhiko Kuroda steps down from his position at the beginning of April.

Yamaguchi asked investors to pay attention to Kuroda’s speech after the BoJ’s policy meeting this week. He added that the bank was likely assessing the effect of recent policy changes on the economy.

Given that the Japanese central bank insists on maintaining its dovish interest rates, economists predict that the BoJ will widen its inflation target. Currently, the BoJ aims to bring down inflation to two percent, but it may increase the tolerance to three percent in the future.

Japan is expected to post a four percent core inflation in December 2022. Despite being the country’s highest inflation rate in decades, the level is still well below the average of developed economies.