JPY: Relative rates to be a factor driving weakness – Danske Bank

Analysts at Danske Bank expect the Bank of Japan to keep policy unchanged for the next 12M and sees relative rates as a factor driving JPY weakness.

Key Quotes

“We target EUR/JPY at 122 in 1M, 124 in 3M, 129 in 6M and 135 in 12M.”

“Outlook for EUR/JPY

We expect the Japanese economy to continue to grow above trend in coming years. While exports and production have been on an increasing trend, mainly on the back of the cyclical improvement in the global manufacturing sector, domestic demand remains supported by the government’s fiscal stimulus package. We estimate annual Japanese GDP growth of 1.2% in 2017 and 0.9% in 2018 (FY 2016 1.3%, FY 2017 1.1%).

Since the introduction of Yield-Curve Control (YCC) in 2016, under which the Bank of Japan (BoJ) now targets both the short-term policy interest rate (at -0.1%) and the 10Y Japanese government bond (JGB) yield (at 0%), the BoJ has de facto tapered its JGB purchases and is currently buying an amount equivalent to an annual pace of JPY60trn. We expect the BoJ to keep its policy unchanged throughout our 12M forecast horizon and, while the BoJ could taper further, we think the yield spread relative to the US – and not the amount of JGB purchases – will remain a key driver for JPY crosses in general.

On 10 May, BoJ Governor Haruhiko Kuroda, in a speech to Parliament, said that the current pace of JGB purchases is around JPY60trn per year and thus lower than the BoJ’s previous annual purchase target of JPY80trn. As such, the scale down of JGB purchases has been evident in the BoJ’s publicly available data since the BoJ changed its monetary policy framework in September 2016 when it introduced yield curve control. For the FX market, we highlight that the yield spread – and not the amount of JGB purchases – is the main driver for JPY crosses as higher foreign yields support Japanese demands for foreign bonds and encourage Japanese investors to reduce the hedge ratio on foreign assets as hedging costs increase.”