BoJ's Potential Shift in Monetary Policy – Is it time to Short USDJPY?

At the beginning of this week, major foreign exchange rates have maintained narrow trading ranges. The USD/JPY pair, after reaching a peak at 150.84, retreated to levels below 150.50 overnight. This shift followed the release of a robust Consumer Price Index (CPI) report from Japan, which exceeded expectations. The report indicated that both headline and core inflation measures experienced milder deceleration in January than anticipated.

Japan CPI

In specific figures, headline inflation slowed by 0.4 percentage points to 2.2%, while Japanese core inflation (excluding fresh food) decelerated by 0.3 percentage points to 2.0%. According to Bloomberg, the unexpected upside surprise was attributed to a substantial increase in the prices of foreign tour packages (+62.9% YoY). Notably, these prices were compared with levels four years earlier, rather than a year earlier. The Ministry of Internal Affairs and Communication clarified that the base of comparison for prices was January 2020, as they had halted price surveys during the past three years due to challenges in collecting stable price data during the COVID period.

It is crucial to recognize that the higher inflation readings in January are influenced by a one-off technical factor related to the comparison base for prices. This factor is expected to temper the Bank of Japan's (BoJ) reaction to the CPI report, preventing an overly hawkish stance.

However, market analysts still maintain the belief that the BoJ is laying the groundwork for a potential exit from negative interest rates, and this shift could materialize as early as the next policy meeting in March. Short-term interest rates in Japan have been on an upward trajectory, fuelled by growing speculation over BoJ rate hikes. The yield on the 2-year Japanese Government Bond (JGB) has surged from a mid-January low at 0.0% to a recent high of 0.18%, marking the highest level since mid-2011.

Governor Ueda's recent statements in the Diet last week added to this speculation, as he expressed optimism about the virtuous cycle of higher wages and inflation strengthening. Ueda noted that signs of increased business activity in wage decisions were observed as labour demand tightened. He emphasized that companies in Japan are becoming more assertive, suggesting a positive outlook.

Market observers sense a growing confidence within the BoJ regarding potential wage increases. If the central bank is swayed by incoming positive economic information, there is a possibility that they might decide to hike rates in March. The weaker yen could also play a role in this decision. An earlier rate hike may help mitigate the risk of the yen depreciating further, particularly in the current environment that encourages the establishment of yen-funded carry trades. The latest International Monetary Market (IMM) report disclosed a significant increase in yen short positions by leveraged funds this month. These factors collectively contribute to the evolving narrative surrounding the potential shifts in the BoJ's monetary policy.

Insights Inspired by MUFG: Credit to Their Analysis for Shaping Some Aspects of This Text

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