Fundamental Forecast for the Japanese Yen: Bullish

- DJP Loses Majority in Upper House
- Bank of Japan Holds Key Rate at 0.10%
- The Speculative Run in Capital Markets Starts to Flag on the Absence of Fundamentals

The Japanese Yen rallied to a fresh yearly high against the greenback, which pushed the USD/JPY to 86.25, and the low-yielding currency may continue to appreciate over the following week as investors scale back on their appetite for risk. Meanwhile, the Bank of Japan raised its growth forecast and sees economic activity expanding at an annual pace of 2.6% for the year ending March 2011 amid an initial forecast for a 1.8% rise in GDP, but voted to keep the benchmark interest rate steady at 0.10% as the central bank expects the rebound in growth “to slow down in coming months.”

The policy statement accompanying the rate decision said that country will stay on its current path to recovery as it benefits from the marked expansion in the emerging economies, but noted that countering the risks for deflation remains the most critical challenge as policy makers aim to balance the risks for the region. In addition, BoJ Governor Masaaki Shirakawa said that the recent appreciation in the exchange rate could hamper the rebound in economic activity as it curbs the competiveness of Japanese goods, but went onto say that the region is headed towards a sustainable recovery, although the rebound in the second and third quarter may fall short of the expansion seen during the first three-months of 2010. In addition, the central bank head argued that the recovery is spreading into the private sector as businesses expand their rate of production, with households holding an improved outlook for the economy, but the board is likely to maintain a loose policy stance throughout the second-half of the year as the prospects for future growth remains clouded with uncertainties.

At the same time, the International Monetary Fund stated that the BoJ should support the economy in an effort to mitigate the risks for deflation, and argued that the central bank should closely watch “carry trade activities and their impact on the exchange rate” as the appreciation in the Japanese Yen drags on the outlook for future growth. Moreover, the IMF said Japan’s plan to balance public finances over the 10 years “will only become fully credible once details of the necessary revenue measures are agreed on including the timing and scale of a consumption tax increase,” and went onto say that the government needs a “cap on public debt to anchor expectations” as the global financial system remains fragile. Nevertheless, BoJ Governor Shirakawa will be in attendance at the Asia Pacific central bank meeting in Sydney on July 20, and comments from global policy makers could certainly spark increased volatility in the exchange rate as investors weigh the prospects for future policy. However, as the economic docket for the following week remains fairly light and lacks market moving potential, the Japanese Yen is likely to track risk developments as market sentiment continues to dictate price action in the currency market.

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