Weekly Report

As expected the Bank of Japan (BoJ) left unchanged its monetary policy on 21 May. Despite having lowered its GDP forecasts on 30 April, the BoJ remains comfortable with its above consensus inflation outlook. Indeed, the central bank views further firm domestic demand boosting the recovery, which should continue to tighten the labour market. Furthermore, the rise in medium- to long-term inflation expectations supports higher wages and price settings. Therefore, in the short-term, the continued lack of any hint towards potential further easing coupled with elevated short JPY positions leave the yen vulnerable to a phase of strength. However, the BoJ’s inflation outlook remains in our view too optimistic, especially given headwinds from the waning effect of the weaker yen and the persistent erosion in Japan’s exports. Besides, sustainable strength in the yen would likely be unwelcome by the BoJ given its disinflationary effects. The next key release is likely the Tankan survey on 1 July, which will show if company expectations for prices are also optimistic than the BoJ. If it was not the case, the BoJ would likely have to ease during its July meeting to support inflation expectations.