Confronted with a weakening yen, the Bank of Japan may lean towards raising interest rates again in the coming months. Yusuke Matsuo, Senior Market Economist at Mizuho Bank, stated, "The Bank of Japan has outlined the logic that could justify further rate hikes if the yen continues to depreciate. If necessary, scheduled public appearances by comparatively hawkish policy board members could ultimately encourage market participants to consider more seriously the possibility of a rate hike as early as April, or even March."
The analyst indicated that board members would use these appearances to prevent potentially highly disruptive "surprise" interest rate moves. He added, "Accordingly, we advise paying close attention not only to the substance of what the board members ultimately say but also to the exchange rate levels around each speech, and any shifts in tone regarding the prospects for rate increases."
The yen has been under significant pressure as markets perceive the government's intention to run the economy "hot" through tax cuts, increased spending, and encouraging the central bank to maintain low interest rates for as long as possible. Since the new prime minister took office, the yen has depreciated sharply, and domestic interest rates have risen considerably. Prime Minister Takachi is scheduled to hold an election next week to boost her popularity. Polls suggest she is expected to consolidate her power with a comfortable victory. If the Bank of Japan signals a willingness to raise rates, it could provide a counterbalance to the yen's weakness.
Another imminent risk event for the yen is the replacement of Asahi Noguchi, whose term on the Bank of Japan's policy board expires at the end of March. Whom Prime Minister Takachi selects as the successor will send a strong signal about how she believes the central bank's policy should be conducted. The choice will be between "reflationists," who would advocate for a longer period of lower interest rates to stimulate the economy and inflation, and "hawks." However, Mizuho warned that if Takachi ultimately opts for a reflationist, "then we anticipate further weakening of the yen," as markets would perceive the government's true "reflation" intentions.
Recently, downward pressure on the yen has eased somewhat due to signs that Japanese authorities are preparing for direct market intervention to support the currency. However, without a clear fundamental shift in fiscal and monetary policy, such intervention would likely only delay the yen's depreciation.
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