JPY rallies after the BoJ left monetary policy unchanged
The Japanese yen (JPY) rallied from above 111.50 against the US dollar to below 109 after the Bank of Japan (BoJ) voted 8-1 to leave monetary policy unchanged today. This disappointed market expectations, including us that the BoJ will increase their qualitative and quantitative easing (QQE) program and lower lending rates to banks to stimulate the economy. It does seem that the BoJ is more tolerant towards short term weakness in exports and inflation with their view that exports and inflation are expected to increase moderately as the outlook for emerging economies and crude oil prices improve. The BoJ estimates that potential growth rate in Japan is in the range of 0.0-0.5% and remain optimistic that the output gap will turn positive in the second half of FY 16. The BoJ is also of the view that the improving labor market and wage negotiations will support wage growth and inflation. Nevertheless, the BoJ has downgraded their FY 16 and FY 17 GDP forecast to 1.2% (from 1.5%) and 0.1% (from 0.3%) respectively. In addition, inflation forecast has also been lowered to 0.5% (from 0.8%) and 1.7% (from 1.8%) in FY 16 and FY 17 respectively. Separately, the BoJ introduced funds supply operation to support financial institutions in disaster areas of the recent Kumamoto earthquake. The duration of each loan (not exceeding 300bn yen) will be within 1 year with an interest rate of 0% per annum.
Downside risk to our 2016 Q2 USD/JPY forecast
In the absence of the Fed raising interest rates or the BoJ increasing their monetary stimulus in the coming months, we see material downside risk to our 2016 Q2 USD/JPY forecast of 113. We do not rule out that USD/JPY could retest the recent low of around 107.63 in the short term. We also doubt that the Ministry of Finance will intervene to weaken the JPY unless volatility in the currency reaches extreme level or USD/JPY declines closer towards 100.