Fundamental Forecast for the Japanese Yen: Neutral

The Japanese yen strengthened against the greenback during the holiday trade, with the USD/JPY retracing the advance from earlier this month, but the exchange rate is likely to trend sideways going into 2011 as it maintains the narrow range carried over from November. As currency traders return from the Christmas holiday, the dollar-yen is likely to face increased volatility over the following week, and the pair may consolidate ahead of the New Year as price action continues to hold above the 50-Day moving average at 82.65.

After holding the benchmark interest rate at 0.10% earlier this week, the Bank of Japan pledged to “steadily purchase various financial assets and provide longer-term funds” in order to stimulate the ailing economy, and reassured that the central bank will take the appropriate steps to curb the risks for deflation as the economic recovery seems to be “pausing.” At the same time, Japan’s Cabinet Office said the government "will continue to take bold action including currency intervention” as the rise in global trade tapers off, and the BoJ policy meeting minutes due out next week could highlight an increased willingness to expand monetary policy further as the central bank struggles to stem the downside risks for growth and inflation. The BoJ may look at alternative measures to weaken the national currency further as it aims to encourage an export-led recovery, but the uncertainties underlying the global outlook could spur increased demands for the Japanese Yen as market sentiment falters.

In turn, speculation for a BoJ intervention could lead the USD/JPY to reverse course and pave the way for a bullish breakout in the exchange rate, but the drop in market liquidity is likely to keep the pair within its current range as global investors close their books ahead of the New Year. As a result, we should see the dollar-yen consolidate in the week ahead, and the sideways price action certainly lays out a clear range-trade setup for the pair as price action continue to hold between 82.30-84.50.

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