Don’t fight the Bank of Japan!

Tom Tong03/Jul/2013Currency Updates

It has been almost three months since the Bank of Japan announced on April 4th a very aggressive set of new policies. It promised to deliver 2% inflation by 2015, up from current negative levels. The monetary target was changed from the overnight rate to the size of the monetary base, and asset purchases will expand dramatically. As a result the Yen fell sharply over the following weeks. (Figure 1). However, the recent market turmoil caught traders wrong-footed with stretched short Yen positions, and the ensuing position squaring has meant dramatically increased volatility in the value of the Yen.

Bank of Japan announces aggressive measures

Figure 1: GBPJPY year to date exchange rate. Source: Bloomberg

Beyond short term market volatility, it is becoming clear that the Bank of Japan new policies, combined with aggressive fiscal stimulus by the Government (collectively known as Abenomics) is working as intended.

  1. The news on the inflation front are particularly good. Since the BOJ announcement, nationwide core CPI has moved up. By this key inflation measure, deflation in Japan ended in May (Figure 2). Tokyo core inflation, which is available a month in advance and usually leads the national figure, was solidly positive in June, at +0.2% (Figure3). This success is particularly notable given the generalized trend towards lower inflation in the rest of the developed world.

Figure 2: Japan nationwide core inflation. Source: Bloomberg

Figure 3: Tokyo core inflation. Source: Bloomberg

  1. Demand indicators released over the past few days are also consistent with a sustained improvement. Industrial production in May jumped 2% month-on-month, after a 0.9% gain in April (Figure4). Retail trade (a good proxy for consumer spending) also rose 1.5% for the month.

Figure 4: Japan industrial production, month on month change. Source: Bloomberg

Figure 5: Japan retail trade, month-on-month change. Source: Bloomberg

  1. May labor market reports were particularly encouraging. Unemployment was flat, labor force participation rose, and the ratio between job offers and job applicants (a key leading indicator) jumped.

The Bank of Japan could hardly have hoped for more encouraging news. Inflation, spending, production and employment all seem to be responding positively to its new aggressiveness. These positive results should serve to address concerns that Policy Board members may have had over the boldness of the policies.


When the Bank of Japan announced its new easing policy, the Japanese Yen sold off dramatically in response (Figure 1). After bottoming out around 102.50 JPY to the dollar, it rebounded strongly amidst generalized market turmoil in June. The new hawkishness in the Federal reserve brought about some counterintuitive market moves (see our Special Report on FX positioning, as the most popular trades of the last few months were unwound by traders and hedge funds caught wrong-footed. Hence, JPY retraced about 2/3 of its losses to peak on June 17th at around 94 to the dollar.

Since then, the trend towards lower Yen has resumed. A weaker yen is both the logical result of the Bank of Japan’s aggressive easing, and a welcome development that will help to raise inflation and exports. Further pressure towards yen devaluation comes from higher nominal and real interest rates in the US, as the Federal Reserve prepares to “taper” QE3.

If the past few years have told us anything, is that major Central Banks can and do get what they want. We maintain our forecasts for a weaker yen in the short, medium and long term.


Written by Tom Tong

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