Fundamental Forecast for Japanese Yen: Neutral

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The Japanese Yen weakened against most of majors following a rebound in market sentiment and the rise in risk appetite may continue to drag on the exchange rate over the following week, but comments from the Bank of Japan could spur increased volatility in the exchange rate as investors weigh the prospects for future policy. The Bank of Japan is widely expected to hold the benchmark interest rate at 0.10% next week as the world’s second largest economy struggles to shake off the recession, and the central bank may look to expand monetary policy further as Prime Minister Naoto Kan pledges to stem the risks for deflation.

At the same time, Finance Minister Yoshihiko Noda said that he has no “indention to push the BoJ to incorporate” inflation targeting in its agenda for monetary policy, and went onto say that “the bank operates with its own understanding for price growth” while speaking with reporters in Tokyo earlier this week. In addition, Mr. Noda noted that the “excessive and disorderly movements” in the currency market could “negatively impact” the economy, and stated that he would like to see the Japanese Yen weaken “a bit more” in order to support an export-led recovery. Moreover, the Finance Minister pledged to restore public finances and monitor developments in the global financial market as the European debt crisis persists, and said that it remains too early to scale back support for the real economy as the private sector remains weak.

As a result, BoJ Governor Masaaki Shirakawa may see scope to loosen monetary policy further in order to mitigate the downside risks for growth and inflation, and the central bank may take steps to temper the appreciation in the nation’s currency over the coming months in an effort to promote a sustainable recovery. Nevertheless, as risk trends continue to dictate price action in the currency market, a reversal in market sentiment is likely to spark increased volatility in the exchange rate over the following week as the Japanese Yen remains the most popular funding-currency.

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