Yen plummets ahead of BOJ policy meeting

Important Calendar Events

• JPY: BOJ Policy Rate, Monetary Policy Statement, BOJ Press Conference
• EUR: German PPI, German Unemployment Change, Current Account, Consumer Confidence
• USD: Building Permits, Housing Starts

USD

The dollar index edged lower in early trading on Monday, dropping as low as 104.1, but gained strength during the day, climbing to 104.8. US Treasury yields rose after plummeting last week, with the US 10-year bond yielding almost 3.6%.

Looming global recession bolstered the safe-haven dollar on Monday. Recession concerns rise, as more major Central Banks tighten their fiscal policies. Hawkish Fed rhetoric also provided support for the dollar, as FOMC member Loretta Mester stressed on Friday that interest rates need to go further up to combat soaring inflation.

Last week, FOMC members voted to raise interest rates by another 50 basis points bringing the Fed’s benchmark interest rate in a range of 4.25% to 4.50%. The rate hike was in line with expectations and had already been priced in by markets. US Fed Chair Jerome Powell delivered a hawkish speech after the monetary policy meeting, pointing to further rate hikes. 

The interest of market participants is now mostly focused on what lies ahead for the Fed. Cooling price pressures may give the US Federal Reserve some leeway to scale back its interest rate increases in the following year. US economic outlook and inflation will likely determine the pace of rate hikes in 2023. 

US inflation cooled in November, with monthly CPI rising by only 0.1%, versus the 0.3% predicted. US headline inflation was 7.1% year-on-year in November, against 7.3% expected and 7.7% in October. 

Only minor economic activity indicators are due on Tuesday for the US, including Building Permits and Housing Starts. Fed rhetoric will likely be one of the primary drivers of the dollar in the coming weeks.

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EUR 

The Euro traded sideways against the dollar on Monday, with the EUR/USD rate oscillating around the 1.060 level, testing the resistance near 1.061. If the EUR/USD pair declines, it may find support at 1.042 and further down near 1.029. If the currency pair goes up, it may encounter resistance at 1.061 and higher up near 1.078.

German IFO Business Climate data released on Monday were more positive than expected, providing support for the Euro. The German Business Climate rose to 88.6 in December from 86.4 in November, indicating improving business sentiment. 

ECB Vice-President Luis de Guindos delivered a hawkish speech on Monday, stating that the ECB will is committed to bringing inflation down to its 2% goal and will hike interest rates further.

The ECB raised interest rates by 50 bp last week, bringing the benchmark interest rate to 2.50%, which was in line with expectations. ECB President Christine Lagarde though, delivered a decisively hawkish speech, stating that interest rates need to rise significantly to combat entrenched Eurozone inflation. 

The ECB also revised its inflation forecast for 2022 to reach an average of 8.4%, which was higher than previous forecasts. Soaring EU inflation rates are forcing the ECB to hike rates aggressively to reduce price pressures. Cooling price pressures in the US on the other hand, have trimmed Fed rate hike expectations for 2023. The ECB’s hawkish shift compared to the Fed’s more dovish forward guidance is turning the tide in favor of the Euro. 

Final Eurozone inflation reached 10.1% year-on-year in November from an earlier flash estimate of 10.0%. Revised GDP for Q3 of 2022 exceeded expectations, with the Eurozone economy expanding by 0.3% versus the 0.2% predicted. The ECB however, updated its economic growth forecast by 3.4% in 2022, 0.5% in 2023, 1.9% in 2024, and 1.8% in 2025. These are lower than previous estimates, indicating that the economic outlook in the Eurozone is poor.

On the data front, important economic activity indicators are scheduled to be released on Tuesday for the Eurozone and may cause volatility in the Euro price. These include German PPI, German Unemployment Change, Current Account, and Consumer Confidence.

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GBP

The Sterling traded sideways against the dollar on Monday, with GBP/USD moving around the 1.217 level. If the GBP/USD rate goes up, it may encounter resistance at 1.234, while support may be found near 1.189 and further down near 1.176. 

UK GDP for October showed a 0.5% expansion, versus a 0.4% expected and a 0.6% contraction in September. Annual CPI dropped to 10.7% in November, after hitting a 41-year high of 11.1% in October. Cooling price pressures alleviated some of the pressure on the BOE to raise interest rates. 

Accordingly, BOE members voted to hike rates by 50 bps last week, bringing the BOE’s interest rate to 3.50%, its highest rate in 14 years. The rate hike was in line with expectations however and had been fully priced in, putting pressure on the Sterling. 

The BOE also revised its economic growth projections, with GDP expected to drop by 0.1% in Q4 2022 following a decline of 0.5% in Q3. The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down.

BOE Governor Andrew Bailey delivered a surprisingly dovish speech after the meeting, expressing hope that inflation in the UK would drop, but leaving the door open for further rate hikes. There were also mixed messages from the BOE, with 6 MPC members voting for the 50-bp rate hike, two others to maintain interest at its current rate, and another member in favor of a 75-bp increase. 

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JPY

The Yen exhibited high volatility on Monday, rising in early trading, but plummeting later in the day. USD/JPY dropped as low as 135.7 but pared losses later in the day, climbing above 137. If the USD/JPY pair declines, it may find support at 133.6. If the pair climbs, it may find resistance at 139.9 and further up at the psychological level of 142.2.

The BOJ monetary policy meeting is going to take place on Tuesday and is expected to cause some volatility in the Yen price. Japanese policymakers will announce the central bank’s interest rate, although this is expected to remain unchanged. So far, the BOJ has maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, even as inflation in Japan has gone above the BOJ’s 2% target. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down. 

Reports that the BOJ would pivot to a more hawkish policy boosted the Yen early on Monday. Rumors that the Japanese Government might issue on Tuesday a joint statement with the BOJ revising the central bank’s inflation target were circulated on Monday. The joint statement was reported to contain a commitment to maintaining the 2% inflation target, increasing the odds of a tighter fiscal policy down the line. The Yen plummeted later in the day, however, as most analysts don’t expect a decisive move in Tuesday’s policy meeting.

Market participants will follow closely the BOJ press conference following the conclusion of the policy meeting for hints into the BOJ’s future policy. BOJ Governor Haruhiko Kuroda is known for his persistently dovish stance and it will be interesting to see if the BOJ will change its forward guidance in the face of rising inflation. Kuroda is due to retire in April however, and his successor may decide to unwind the BOJ’s ultra-easy policy.

Price pressures continue to rise in Japan, as annual PPI rose to 9.3% in November, versus the 8.8% predicted. BOJ CPI for October rose to 2.7% on an annual basis, mainly due to the high cost of imported energy. 

The final GDP Price Index for the third quarter of the year showed economic contraction by 0.3% on an annual basis and the final quarterly GDP for Q3 of 2022 printed at -0.2%. The Japanese economy shrank in the third quarter of 2022, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy. 

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Written by:
Myrsini Giannouli

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