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The yen has fluctuated considerably in the wake of the latest release of BoJ minutes, as market participants digested some of the comments. Not surprisingly, the debate revolves around how to interpret inflation trends. This is particularly relevant now with the release tomorrow of May inflation figures for Japan.

Inflation in Japan rose and fell without much change in monetary policy by the BoJ. Which is a very different situation from the rest of the world. But, will Japan eventually be subject to the same dynamics as other major economies, and therefore be forced to raise rates? That’s part of the speculation that has driven some of the price action in yen pairs lately.
 

Potential changes

What set speculation going was an expectation in the minutes of the meeting that inflation in Japan would come down to target through the summer. Some analysts voiced the view that this means the bank is setting up the conditions for raising rates when inflation doesn’t meet the target in that time frame. Many market participants think the BoJ is wrong to expect inflation to come down “on its own”, as it were. So, whether it’s planned or not, the thought is that when autumn comes around and inflation is still above target, the BoJ will have to start tightening.

Proponents of this view could point to some comments by a BoJ Board member who was seen as “dissenting”. The BoJ works on strong consensus, so doesn’t have “dissenting” votes in the way other central banks do. Members are typically unified in their stance. But Board Member Adachi’s comments were seen as potentially exposing some cracks in that unity, and he admitted that inflation was increasing faster than he had initially expected. He also suggested that views on inflation were changing, which could open the door to monetary policy “tweaking”.
 

Time for some tightening?

The only “tweaking” that’s currently available to the BoJ is tightening. That could be seen as another widening of the YCC, or doing away with it altogether, both options seen as a step away from ultra-easing and towards an expected future rate hike.

But, that is mere speculation, and the BoJ remains steadfast in insisting that no tightening is on the horizon, even as the government tries to “warn” the market that the yen is getting too weak.
 

It’s a delicate balance

The weakness of the yen is the crux of the issue. On the one hand, inflation is seen as a result of the weak yen's rising import costs. It is also seen as supporting organic economic growth, with Japan’s GDP growing at an unexpected rate, in part thanks to increased exports. The BoJ really wants that organic growth to boost inflation to its target. But the weaker yen is raising prices inorganically, with inflation currently above target for the wrong reasons. Any attempt to bring down the currently high “bad” inflation by tightening could risk killing off the “good” inflation from growth thanks to the weaker yen.

Tomorrow’s data might offer some clarity, with annual inflation expected to come down to 3.2% from 3.5% prior. The core rate is expected to also hit 3.2% compared to 3.4% prior. BoJ Governor Ueda’s comments that might come in the aftermath of the data will likely be closely scrutinized.

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