Whether the Bank of Japan’s decision to leave interest rates on hold at the January board meeting genuinely reflected concerns over price trends and activity or whether it was more a consequence of the growing political pressure to which the bank has been subjected (to keep policy on hold), the December CPI report from Japan must surely be seen as a further obstacle in the process of monetary policy normalisation.
Of course, that prices rose just 0.1 per cent year-on-year in December as opposed to the 0.2 per cent that had been anticipated is neither here nor there when it comes to assessing the strength of lingering deflationary pressure. But economy minister Hiroko Ota was clearly not going to look a gift horse in the mouth. By implying that inflation is making little forward progress, Ms Ota once more raised the burden of responsibility that would weigh upon the Bank of Japan were it to act in defiance of the government’s expressed concerns. However, it would be naive to assume that there is unanimity of view on the Bank of Japan’s board that would denote a uniform susceptibility to external pressure.
Indeed, board member Miyako Suda has said: “… by taking too much time in confirming [data], there is a risk of being too late in raising rates, forcing us to step up the pace of future rate hikes … That would result in causing big swings in economic activity and may hurt price stability in the long run.” And comments from Toshiro Muto were perhaps of even greater interest: the deputy governor made clear that the Bank would “take overseas concerns about yen weakness into consideration in its policy”.
Mr Muto’s comments followed a report by Reuters which cited a “source close to preparations” for the forthcoming G7 meeting in Germany as stating: “The drafting of the G7 communiqué is a job for all those involved … [but] with respect to the yen, [the European position will be] relatively clear - that there will be a more forceful repetition of the message that was already given after the Singapore meeting … that the evolution of the yen should be in line with economic fundamentals”. In view of the fact that Jean-Claude Trichet commented on improving Japanese economic fundamentals in the aftermath of the Singapore meeting of the G7 last September, it is clear what is being implied by this “evolution”.
Hence, knowing the likely position of the eurozone contingent at February’s G7 meeting in Germany, it could well be that Mr Muto feels there is mileage in highlighting yen weakness in order to add pressure upon the Japanese government to grudgingly sanction a rate hike. However, we have our doubts that such assurances would be forthcoming. Indeed, perhaps the best that can be realistically attained by the European contingent at next month’s G7 – given that the group’s standing on market forces (assumedly) precludes demands for direct intervention – is a renewed vow of intent on the part of the Japanese to clarify the need for currencies to reflect economic fundamentals. But even then, it is the actual, perceived strength of underlying economic fundamentals that is at issue, not the importance of their influence on currency performance. Perceptions of Japanese economic strength are not necessarily shared between Brussels and Tokyo.
Therefore, albeit with some potential for a modest rebound in the wake of any ‘G7-style’ rhetoric, the yen’s future seems likely to remain at the mercy of low Japanese yields. Perhaps the depth of feeling amongst Japanese investors that there are higher returns available offshore is reflected in the fact that their outflows have continued to offset the continued foreign interest in Japanese equities – interest which is demonstrated in the above chart.
Neil Mellor is a currency strategist at the Bank of New York.
Researched and published in association with the Bank of New York.
