Bank of Japan expected to keep rates on hold, trim bond purchases

• The Bank of Japan is expected to hold interest rates and trim bond purchases on Wednesday.
• The BoJ’s quarterly forecasts and Governor Kazuo Ueda’s words will grab more attention.
• The BoJ policy announcements are set to infuse massive volatility into the Japanese Yen.

The Bank of Japan (BoJ) is expected to hold its short-term rate target in the range between 0% and 0.1% when the two-day July monetary policy review meeting concludes on Wednesday.

The BoJ decision will be announced at around 3:00 GMT, accompanied by the bank’s quarterly outlook report. Governor Kazuo Ueda’s press conference will follow at 06:30 GMT.

What to expect from the BoJ interest rate decision?

The BoJ is set to stand pat on interest rates for the third consecutive meeting after ending eight years of negative rates in March.

The Japanese central bank is likely to debate whether to raise interest rates at its meeting next week, Reuters reported on Friday, citing four sources familiar with the BoJ's thinking.

One of the sources said, "the decision will be a close call and a hard one to make," given the uncertainty over the consumption outlook. "It's really a judgment call, in terms of whether to act now or later this year," another source said.

Meanwhile, “the Bank of Japan must raise interest rates to prevent excessive declines in the Japanese Yen,” private-sector members of a key government council advocated at a meeting earlier this month where Governor Kazuo Ueda was present, Minutes of the meeting showed on July 24.

Some politicians have called on the BoJ to offer more clarity on its rate hike plan partly to stem the Yen’s fall to multi-decade lows against the US Dollar.

The swaps market is pricing in a 70% chance that the BoJ will hike rates by 10 basis points (bps), lifting the rate target to the 0.1% and 0.2% range.

The BoJ, however, is almost certain that it will scale back its massive JPY6 trillion ($38.14 billion) monthly Japanese government bonds (JGB) purchase programme, as indicated by them at its June policy meeting.

Back in June, the central bank did not make any changes to the monthly JGB buying programme but indicated that they “will decide on specific bond buying reduction plan for the next one-two years at next policy meeting.”

Some respondents urged the BoJ to reduce its monthly government bond purchases to around 2 trillion to 3 trillion Yen ($12.4-$18.7 billion), from the current 6 trillion Yen, a summary of the survey released by the central bank showed on July 9.

Analysts at BBH preview the BoJ policy announcements, noting that “if policymakers really want to prevent the Yen from weakening again, it should deliver a hawkish surprise on both accounts. Updated macro forecasts will be released at this meeting and should also be tweaked to support the case for further tightening. Unfortunately, recent weakness in the economy suggests the BoJ will disappoint this week.” 

How could the Bank of Japan interest rate decision affect USD/JPY?

“Recent Yen strength has been driven by expectations of a hawkish BoJ decision this week. If the BoJ disappoints, then much of that rally will quickly reverse. And even if the BoJ delivers, there is potential for a “buy the rumor, sell the fact market reaction,” the BBH analysts added.

Should the BoJ surprise with a 10 bps rate hike or communicate a hawkish message in the policy statement, the Japanese Yen (JPY) could see an extension of the ongoing recovery from 38-year lows against the US Dollar (USD). However, the initial reaction to the policy announcements could quickly turn into a ‘sell the fact’ trading, as explained above.

On the other hand, if the central bank sticks to its previous language, that it would cautiously monitor the likelihood of achieving 2% trend inflation to gauge the next rate increase, it could be read as dovish. The downward revision to the growth and inflation forecasts could also lean in favor of doves. In such a case, the Japanese Yen is expected to come under intense selling pressure, lifting USD/JPY back toward the 160.00 figure.

From a technical perspective, Dhwani Mehta, Asian Session Lead Analyst at FXStreet, notes: “Amid extremely oversold Relative Strength Index (RSI) conditions on the daily chart, a USD/JPY rebound seems inevitable.”

A dovish BoJ policy outlook could revive the Japanese Yen downside, driving the pair toward the 157.85 supply zone, where the 21-day Simple Moving Average (SMA) and 50-day SMA converge. Ahead of that level, the 100-day SMA at 155.65 is set to test bearish commitments. If the upswing gains traction, USD/JPY could aim for a retest of the 160.00 round figure. On the flip side, a sustained move below the 200-day SMA at 151.60 could accelerate the bearish momentum toward the 150.00 psychological barrier,” Dhwani adds.