Financial markets are getting ready for the long- awaited Bank of Japan two-day policy meeting that started today, with the policy statement being released on Tuesday, July 31st. There is no certainty on what the outcome of the meeting will be but it comes down to two possible scenarios, whereby the BoJ will either tweak their current policy or keep monetary policy unchanged with no meaningful adjustment. Out of the two scenarios we believe there is a higher chance that the latter will happen.
While all central bank decisions usually result in higher volatility in the financial markets, the BoJ might make the most significant contribution to changing the current dynamics when it announces its latest decision early tomorrow morning. The 10-year Japanese government bond yields have hit their highest level since January 2017 at 0.11% today, as investors began pricing in an expected change in BoJ’s yield curve control policy which was put in place to keep yields at 0%.
Scenario One: Tweaking Current Policy
Several reports indicate that the Japanese central bank is considering tweaking or fine-tuning its stimulus program. The BoJ may decide to move forward with this option because of lower bank profitability and muted inflation in Japan. The idea of tweaking is actually popular as it does not require any major fundamental change in the current policy. Should this be the case, this decision will not only cause a spike in Japanese bond yields but will also have a global effect of further tightening credit conditions and reducing monetary policy accommodation. In this case, USD/JPY will drive lower breaking the 110.50 support and move towards the 109.40 area.
Scenario Two: No Meaningful Change in Policy
Since the Bank of Japan is still far from achieving its 2% inflation goal, it is also possible to keep everything as is and avoid any changes that may indicate backing off from easing. In this case, we would expect the BoJ to prolong the current monetary easing but also start a discussion on letting its policy become more flexible to diminish side-effects. We believe there is a higher chance that the Bank of Japan won’t make any significant changes and will instead try to calm the markets by bringing the 10-year bonds back to 0%. In case of no changes in policy, USDJPY should strengthen again toward the 113.50 resistance.