- BoJ looks set to maintain an optimistic tone, against background of encouraging data…
- …chances of early additional monetary stimulus fading, but could come in the autumn
- We remain negative on the JPY, especially against the dollar and the yuan
Positive data flow from Japan continuing
The relatively encouraging data flow out of Japan is continuing, however the sales tax is creating quite some fog in the numbers. The economy expanded at a faster pace of 6.7% qoq annualized in Q1 compared to the earlier estimate of 5.9%. This was driven by stronger business investment and consumer spending. However net exports remained a drag on the economy as consumers front loaded their purchases ahead of the sales tax hike on 1 April 2014.
BoJ to maintain optimistic view
Against this background, the BoJ is expected to keep monetary policy unchanged this week. We expect the BoJ to maintain its optimistic view that the recovery remains on track and that the 2% inflation target is likely to be achieved in FY 15. As a result the likelihood that the BoJ will increase monetary stimulus in July (coinciding with the interim economic outlook assessment) has faded. Still, we think that the BoJ will eventually be forced to step up its stimulus measures. While core inflation came in higher than expected in April, buying the BoJ some time, we continue to doubt whether the central bank will reach its inflation target in the absence of further declines in the yen. As such, there is a high likelihood that the central bank will need to reduce its inflation forecasts during its October meeting, when its next semi-annual Outlook Report will be released. This would then likely be accompanied by an extension of its monetary stimulus.
Another round of yen weakness
We maintain our view that the Japanese yen will underperform the US dollar and Chinese yuan in the coming quarters. Monetary policy divergence between the BoJ and the Fed will be an important driver. In addition, Japan’s economy is likely to underperform. These factors are likely to result in more outward investment flows. The Government Pension Investment Fund is widely expected to reduce its investment allocation to domestic bonds to more risky assets (both domestic equities and overseas assets) as pension liabilities rise and domestic bond returns disappoint. Domestic life insurers have also indicated that they are more inclined to increase purchases of overseas assets with a lower currency hedge ratio. Meanwhile, safe haven flows into the JPY are also likely to decline as global investor sentiment improves.
Yuan to firm
We judge that the Chinese yuan’s underperformance since the beginning of this year will reverse as China’s economic growth regains some traction and worries about a hard landing ease. The improvement in China’s manufacturing and non-manufacturing PMI and trade balance in recent months have been encouraging. As a result, the People’s Bank of China has allowed the yuan to be fixed at the strongest level since late March this year. We maintain our view that the yuan will recover towards 6.10 against the USD later this year.