Japanese Yen: Supply, inflation and fiscal risks – Rabobank

Rabobank discusses Japanese Yen dynamics around Japan’s high debt-to-GDP ratio, fiscal credibility and the BoJ’s gradual policy normalization. The report argues that a more hawkish BoJ and reassurance over fiscal policy may be needed for a sustained JPY recovery, while forecasting USD/JPY at 159 on a three-month horizon.

BoJ normalization and fiscal anxiety

"Before the bursting of Japan’s asset bubble burst in 1990, the country’s debt GDP ratio was positioned roughly in the middle of the range of all G7 nations. In the thirty years that followed, stagnating GDP combined with high levels of fiscal spending aimed at promoting growth elevated the debt GDP ratio to levels well above the G7 average. For years, Japan’s heightened debt GDP ratio was spoken about in the FX market as a potential issue for future governments and taxpayers, but it was not an issue that was persistently front of mind for the FX market."

"Japan’s exit from the deflation years has allowed the BoJ to move back from extraordinary monetary policy measures. In response to higher inflation, policy rates have been hiked but at a slow and cautious pace. Japan has been one of five G10 central banks to hike rates this year, meaning that it has been difficult for short-term interest differentials to move in the JPY’s advantage."

"Looking ahead, a recovery in real wages, resilience in business confidence and cautious optimism regarding Japan’s economic outlook suggest that the BoJ is on track to hike again this year. That said, an accelerated pace of BoJ rate hikes in addition to reassurances about fiscal policy may both be necessary before USD/JPY turns lower."

"We remain of the view that reassurances on Japan’s fiscal situation combined with a hawkish BoJ are necessary requirements for any turnaround in the value of the JPY."

"Our forecast of a move back to USD/JPY159 on a 3-month view assumes a hawkish BoJ."