On Tuesday Japan central bank kicked off its blockbuster monetary policy meeting for July, and Wall Street expects the Japan central bank to keep interest rates unchanged but announce a quantitative tightening (QT) program to gradually reduce the size of bond purchases.
On the morning of Wednesday, July 31, the Bank of Japan will announce its July interest rate decision, followed by a monetary policy press conference by Japan Governor Kazuo Ueda.
Although most on Wall Street expect the Bank of Japan to remain on hold, there is still hope for the possibility of a rate hike. Netherlands International Group (ING) analysts predicted in a note last week that the interest rate (ceiling) could rise to 0.15% from the current 0.1%, while United States and JPMorgan Chase expect rates to be as high as 0.25%, or a 15 basis point hike.
JPMorgan noted that the market is pricing in a roughly 40% chance of a rate hike in July, but if the Bank of Japan chooses not to raise interest rates, yen rates could move more aggressively.
Citi noted that if the July Japan Bank of Japan's interest rate decision is in line with market expectations, the Japan stock market will not see huge volatility and expects the yen to return to a low of 165 yen against the dollar in the coming months. Previously, the yen soared against the dollar in anticipation of interest rate hikes and is currently hovering around 154.
A "virtuous circle" has not yet formed, and the Bank of Japan is reluctant to risk raising interest rates
According to previous media reports, Bank of Japan Governor Kazuo Ueda told Diet in June that the central bank may raise interest rates based on "economic, price and financial data and information at the time."
Japan's CPI is now unchanged from May at 2.8% in June, while core CPI, which excludes fresh food prices, accelerated to 2.6%, up from 2.5%. Headline inflation has exceeded Japan's 2% target for more than two consecutive years.
The so-called "core of the core" CPI (excluding fresh food and energy prices), the key measure of inflation by the Bank of Japan, rose from 2.1% to 2.2%.
Although inflation has reached or exceeded the Japan BOJ's target interest rate, the central bank has been focused on confirming whether inflation is in a "virtuous cycle" in which higher wages continue to drive prices up.
The Japan Confederation of Trade Unions (Rengo) said on July 3 that large companies with 300 or more union-backed employees had raised wages by 5.19 percent, while smaller companies had raised them by 4.45 percent. The union claims that this is the largest wage increase in thirty-three years.
The latest report from Nomura Securities pointed out that although there have been gradual changes such as wage increases and price increases on the corporate side, household spending has not responded adequately to wage growth and failed to further push up commodity prices, indicating that wages and prices are still forming a "virtuous circle".
Nomura expects the Bank of Japan to leave policy rates unchanged at the upcoming monetary policy meeting, with Citi agreeing.
Citi believes that if the Bank of Japan decides to keep interest rates unchanged, the outlook report and monetary policy press conference released afterwards may convey increased confidence in the outlook for inflation trends based on rising wages and rising inflation expectations.
If the upcoming data is in line with expectations, the Bank of Japan may make it clear that a September rate hike is appropriate.
What is the QT program?
Japan's central bank said in June that it would reduce its purchases of Japan government bonds "to ensure that long-term interest rates form more freely in financial markets."
The market widely expects the Bank of Japan to gradually reduce the scale of long-term bond purchases, which is expected to fall to a rate of 3 trillion yen per month in the next one to two and a half years.
According to data released in March, the Japan central bank is currently buying about 6 trillion yen ($39 billion) of Japan government bonds per month, and media calculations show that as of July 19, the total amount of Japan government bonds held by the Japan central bank was as high as 579 trillion yen.
The media reported, citing sources:
The Bank of Japan is likely to taper its bond purchases over several stages, broadly in line with the dominant market view, to avoid triggering an unwelcome spike in yields.
JPMorgan Chase & Co. also pointed out that if the Japan Bank of Japan's QT plan is more hawkish than market expectations, it could lead to a narrowing of swap spreads on the curve.
Citi's forecast is more aggressive, estimating that the Japan Bank may plan to gradually reduce Japan's government bond purchases to about 2 trillion yen per month in the next one to two years.
Regardless of the size and pace of the reduction, the key is to provide transparency to ensure that the reduction in central bank bond purchases does not create unexpected upward pressure on yen rates, according to Nomura.
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