The Japanese currency was trading at 155 levels to the dollar on Friday, down almost 10% this year, the worst-performing currency in the Group of 10

 

The yen's weakness stems from the wide rate differential between the U.S. and Japan. (Nikkei montage/Source photos by Akira Kodaka and Yuji Murakami)MARKET SPOTLIGHT
Potential for earlier BOJ rate hike rises 

amid hawkish signals, weak yen
Some analysts expect Japan's central bank to use bond yields to stop yen's fall

LISA KIM, Nikkei staff writerMAY 20, 2024 06:00 JS
http://TOKYO -- When the Bank of Japan ended the world's only negative interest policy in March, it emphasized that financial conditions would be kept easy and interest rates would slowly increase. 

That was before the yen traded at multidecade lows even after two suspected government interventions to boost the currency and the BOJ reduced its purchases of Japanese government bonds. 

• It was also before U.S. Federal Reserve officials held onto their outlook of just three rate cuts this year, down from the six that markets expected.

The change of events has fueled the possibility that Tokyo may raise interest rates earlier than expected against the backdrop of the weak yen being partially responsible for higher prices. 

"It would be appropriate to adjust interest rates sooner" than market expectations if inflation goes up faster than forecast, said BOJ Gov. Kazuo Ueda at an event in Tokyo on May 8. 

His comment echoed many BOJ board members' remarks at the April monetary policy meeting. 
The yield on the two-year Japanese government bond -- which is more sensitive to imminent central bank moves -- stands at 0.32%, according to FactSet. This means policy rates are predicted to reach 0.25% in the second half of the year and 0.5% next year. 

"Gov. Ueda's latest speech and details of the April 25-26 monetary policy meeting pushed a more hawkish stance, highlighting that the Japanese yen's depreciation may push up underlying inflation," said Masamichi Adachi, the chief Japan economist for UBS Securities and a former BOJ official. 

Japan's core consumer price index rose 2.6% in March from a year earlier, slightly lower than the previous month, according to government data. 

The Japanese currency was trading at 155 levels to the dollar on Friday, down almost 10% this year, the worst-performing currency in the Group of 10. 

Late last month, the yen plummeted to its recent weakest point, briefly plunging past 160 after the BOJ left rates unchanged at its policy meeting and U.S. personal consumption expenditures rose more than expected in March. 
The BOJ is facing challenges in keeping an accommodative monetary policy, with the weak yen expected to further erode household purchasing power, according to JPMorgan Securities economists Ayako Fujita and Benjamin Shatil. The yen's fall means consumers are dealing with higher import prices for food and energy. 

• Consumption declined in the January-March period from the previous three months as inflation outpaced wage growth, marking the fourth consecutive quarterly drop, according to preliminary data released last week. 

"With the rising risks of capital outflows and inflation, the BOJ likely will be urged to move modestly faster," though monetary officials will be focused on the pace of the yen's depreciation, JPMorgan Securities economists said. 

• They foresee rates as increasing to 0.25% after the July monetary policy meeting and then 0.5% by the end of the year. 
• Unless the yen weakens past 165, the BOJ would need more data-based evidence before raising rates, according to Bank of America Securities economists Izumi Devalier and Takayasu Kudo. 

This way, policymakers "can cite a pickup in underlying inflation as justification for the rate hike as opposed to foreign exchange considerations alone," they said. 

They said the central bank's closely watched Tankan survey of business sentiment for the second quarter, due in early July, would provide an improved outlook on corporate profit, capital expenditures and inflation for policymakers to make a move that month. 
Bank of America Securities has pulled forward its base case for the next rate hike to July, at 0.25%, from September, according to a report earlier this month. It expects another increase to 0.5% in January and then to 0.75% in the second quarter of next year. 
The BOJ said last week it had appointed a new executive director with a background in monetary policymaking in a personnel reshuffle, giving weight to speculation that the central bank had to strengthen policymaking capabilities for upcoming rate hikes.
But some analysts, like Naka Matsuzawa, the chief strategist at Nomura Securities, expect the BOJ to keep rates steady in the very near future and head toward neutral rates. 
Given negative real wages and falling economic sentiment, "there are doubts that the BOJ really wants to raise rates early," Matsuzawa said. 

"Rather than raising short-term rates, they want higher long-term bond yields and a steeper yield curve" to stop the yen from further depreciation, he said. 

• Last week, the BOJ reduced its purchases of government bonds with five to 10 years left to maturity to 425 billion yen ($2.7 billion), down 50 billion yen from its previous operation. 
• But the 10-year Japanese government bond yield stayed relatively flat. Market speculation that the central bank could further cut bond purchases on Friday did not materialize. 

A 2% contraction in Japan's economic growth in the first quarter from the previous quarter has also reduced expectations of higher rates, said Shoki Omori, the chief Japan desk strategist at Mizuho Securities. 
Still, the yen's weakness stems from the wide rate differential between the U.S. and Japan. 

The yen's movement has shown it is more sensitive to U.S. economic data than those out of Japan. 

• The yen rose to 153 levels on Thursday after U.S. consumer inflation data and retail sales showed the economy had cooled in April. 
• The yen surged even as Japan's weaker-than-expected first-quarter economic growth suggested the economy is not in an optimal position for higher rates. 

"The key reason for the yen's depreciation is not on Japan's side, but the U.S. side," UBS Securities' Adachi said, referring to America's 23-year-high interest rates of 5.25% to 5.50%. 

"The BOJ probably won't raise rates higher than 0.5% by the end of this year, in our view, which means the differential will not shrink meaningfully without rate cuts by the Fed," he said.