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Bank of Japan Disappointment Sets Stage For Further Yen Appreciation

Currencies / Japanese Yen Jul 31, 2016 - 12:54 PM GMT

By: AnyOption

Currencies After the considerable fanfare that followed the Liberal Democrats sweeping victory in the upper house of Japanese Parliament, the monetary stimulus measures that have seen been unveiled have not been met with optimism as evidenced by the recent strengthening in the Yen.  In a sign that confidence in the Bank of Japan continues to fall, and recently announcement of expanded JPY 6 trillion in ETF purchases failed to move the needle lower for the Yen.  Anticipation of more aggressive stimulus measures including expanded easing and lower interest rates was not rewarded after the Central bank abstained from making serious adjustments to existing policy measures.  Despite the pessimism that surrounded the decision, it may have been the best move considering the ongoing deflationary pressures that have not budged and weaker consumption metrics.  However, with deteriorating economic fundamentals comes the added risk of another wave of Yen appreciation.

Little In the Way of Fundamental Progress

Based on the latest data reported by Japan over the past several weeks, there are growing indications that the sheer size of the ongoing stimulus programs are not enough to offset faltering fundamentals as economic activity remains unbalanced.  Data released by Japan’s Statistics Bureau overnight showed headline CPI remains under pressure, standing firm at -0.40% on an annualized basis with core CPI falling by -0.50% year over year through the end of June in a sign that ongoing efforts are falling short.  The problems with deflation have bled over into other areas of the economy as evidenced by the latest readings on consumption, with household spending plunging by -2.20% year over year despite forecasts anticipating a slower pace of contraction during the latest period. 

Persistent deflation will likely see consumers continue to postpone purchases amid expectations that prices will continue to fall, exacerbating the problem facing policymakers.  Although some market participants may be optimistic about the pickup in industrial production to 1.90%, the reality for production is that it is merely a rebound from the prior month’s steep contraction of -2.60%.  While markets may have been disappointed that interest rates were not dropped lower and easing was not expanded more aggressively, in many ways it was the smartest play for the Bank of Japan.  It may have upset government officials pushing for more stimulus, however, fighting the current deflationary wave with lower interest rates might have unintended consequences especially as the Bank of Japan runs out of assets to buy. 

One of the more important developments on the back of latest BoJ decision was the emphasis on providing US dollar lending to exporters to help facilitate trade.  Without an improvement in lending which is ultimately the point of quantitative easing and asset purchases, there is limited reason to keep expanding the existing strategy considering its obvious shortcomings.  Improved lending fundamentals will be the key behind any upside potential in inflation, especially considering the accommodative monetary policy backdrop across the global economy.  What is notable about the decision is that instead of blindly adding more stimulus to appease markets, the latest moves are sign that the Central Bank is concerned about the incremental effectiveness of more of the same strategy.  However, the most evident response to the decision is in the Yen, which continued its recent wave of appreciation, hurting the outlook for exporters and inflation.

Technically Speaking

While there was the possibility that EURJPY would reverse from its recent slide if the government stimulus announcement was accompanied by more expansive monetary policy action, no such development came to fruition, sending the pair lower.  After trending in a downward channel formation for over a year, a breakout lower occurred after the “Brexit” results were tallied before the pair managed to climb back into the channel where prices are currently testing the lower channel line.  However, acting as resistance against any sustained upside in EURJPY is the 50-day moving average which is trending lower above the price action, just slightly below 118.00.  Adding to the bearish bias is the 200-day moving average which is also trending lower.  Although the 0.50 Fibonacci retracement level is currently acting as support, a clean close below this level and 0.618 sets the stage for a resumption of the downtrend.

Looking Ahead

In the months to come, it will be important to see both how the global inflationary picture and trade situations evolve when it comes to assessing how EURJPY will behave.  For one, more accommodation from the ECB could very well add to the downward pressures working against the currency pair while any downtick in global trade could also weaken sentiment, causing traders to unwind carry-trades which would also hurt EURJPY.  Unless there is a sharp improvement in Japanese fundamentals, the stage is set for further appreciation as the Bank of Japan limits its efforts while they judge the effectiveness of the new fiscal stimulus program.  Should conditions begin to show signs of improvement, the Bank of Japan may find itself under less pressure to expand its own accommodative measures.  However, in the absence of these scenarios, the risks remain skewed to the downside for EURJPY.

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