Bank of Japan Considers Tightening Monetary Policy Sooner, USD/JPY Dips

Markets received a jolt this Monday as Bank of Japan’s (BOJ) Governor, Kazuo Ueda, hinted at a potential shift in the bank’s monetary policy. Over the weekend, Ueda said he might have enough data by year-end to contemplate raising interest rates, significantly affecting the USD/JPY, which dropped sharply in early trade.

In an interview with Yomiuri newspaper, Ueda stated, “Once we’re convinced Japan will see sustained rises in inflation accompanied by wage growth, there are various options we can take.” Moreover, he added that if Japan could achieve its 2% inflation target after ending negative rates, the bank would proceed to do so.

However, Ueda also tempered expectations for immediate change. He reaffirmed the BOJ’s commitment to ultra-easy monetary policy until inflation will inevitably stabilize around the 2% target. “While Japan is showing budding positive signs, achievement of our target isn’t in sight yet,” he noted.

Additionally, he emphasized the importance of continued wage growth next year, given its connection to services inflation. Consequently, BOJ’s next move may not be to end yield-curve control (YCC), a strategy involving large-scale purchases of Japanese government debt. Instead, it may abandon its overnight policy rate of -0.1%, which has existed since before the Global Financial Crisis.

Even though Ueda’s remarks don’t confirm an end to negative rates, they suggest a possible recalibration based on expected U.S. interest rates. Recently, the BOJ tweaked YCC to allow 10-year yields to move more flexibly, even up to 100 basis points, a significant change from current levels.

Therefore, sustainable inflationary pressures in Japan could lead to longer-dated Japanese yields drifting higher, narrowing the yield differential with the United States without necessarily reducing U.S. yields.

Ueda’s comments had an immediate market impact. The USD/JPY pair plunged, hitting lows of 146.64 and remaining under pressure. This adds weight to the possibility of a near-term downside, especially after the pair struggled to break above 148 multiple times last week. The U.S. dollar index rally also appears fatigued, signaling room for profit-taking.

Besides, macro events could reverse this selloff. A softer stance from the ECB or a hotter-than-expected U.S. CPI report could renew dollar strength. Hence, as the Federal Reserve’s FOMC Committee convenes next week, market watchers will be glued to their screens for any new policy decisions.