BoJ Preview: Forecasts from nine major banks, YCC tweaks are possible

We expect the BoJ to keep the policy rate unchanged. While some market participants are expecting a change in YCC amid JPY weakness, we think the BoJ will adopt a wait-and-see stance for at least the next couple of months. Considering Japan’s long-standing deflation, the BoJ may want to remain dovish for now. While Q1 GDP growth was strong, it is yet to be seen if such growth momentum is sustainable. Japan’s core CPI inflation has stayed above 3% since September 2022 but is likely to moderate below 3% in the second half. The BoJ will likely want to see a stronger wage growth path to keep inflation consistently above 2%. While wage growth for big corporates is higher than 3%, real wage growth remains negative, highlighting the challenge of achieving sustained wage growth.

We believe that recent swings in the FX and Japanese government bond markets reflect market expectations for policy adjustment. It is a close call, but we still think YCC tweaks are possible, given that recent data support steady inflation growth and a sustained economic recovery.

We expect the BoJ to maintain the status quo. Market expectations are mixed and have recently tilted toward a small adjustment in the YCC. We would not rule out such a small change as a risk case but do not foresee any substantial change that could be perceived as an end to monetary easing. Therefore, any modification should be akin to operational fine-tuning to continue easing. The BoJ has consistently reiterated that the Japanese economy still needs further monetary easing and that positive real wage growth in particular is important. In our view, any sudden hawkish shift away from this stance would undermine the credibility of forward guidance and thus increase the risk of long-term interest rates overshooting.

We expect the Bank to leave all policy levers unchanged with no tweaks to its YCC. Ueda's comments have been dovish of late, with Uchida also cautioning against a premature policy shift. We will get updated forecasts and expect the FY24 inflation forecast (the more relevant forecast for policy) to remain unchanged at 2% which may suggest no imminent shift in the BoJ's stance.

Although Ueda pushed back on expectations of a change in its policy settings at the July BoJ monetary policy meeting, he continues to say any change to YCC must come as a surprise. So, if the BoJ were to surprise the market we think it could either: widen further the trading band around the 10y target of 0% or shorten the tenor of the YCC target to 2y JGB. We assign a higher probability to the latter. We maintain our view that BoJ will shorten the tenor of its YCC target to 2y from 10y in coming meetings, with a low expectation of that happening this week.

We see some policy revision as a c.40% probability event but continue to expect no change in monetary stance as his baseline. For the Outlook Report, we expect the BoJ to increase the inflation outlook for FY2023 but lower it for FY 2024, continuing to emphasise downside risks, but with no changes to the growth outlook.

We expect the BoJ to maintain its main monetary policy, i.e. YCC and ETF purchases. We expect that the BoJ will have to revise its inflation outlook upwards at this meeting. However, given the current price pass-through stance of the non-manufacturing industry, the BoJ will repeat its stance that wages are likely to rise as the results of this year's spring wage negotiations are reflected in salaries through the summer, but the outlook is uncertain. It will add that there is a change in firms' pricing and wage settings when looking at recent price developments, but there is uncertainty as to how long it will last. In addition, an upward revision to the inflation outlook is unlikely to be a reason to widen the range. This is because until now, the BoJ has explained that the YCC tweak is not a tightening of monetary policy, but rather a change to enhance the sustainability of monetary easing. Going forward, we still think that the BoJ could widen the range at its September meeting.

We expect the BoJ to maintain monetary policy, YCC included. The focus is on whether there are adjustments to YCC. Market participants expecting adjustment have very different views on upside to Japan’s inflation outlook from those expecting no adjustment. We expect the policy board member median projection in the July Outlook Report to show three years of inflation above 2% starting in FY22. However, given that the BoJ still cannot be sure of FY24 inflation staying around 2%, it will likely prefer being behind the curve along with the risk of inflation exceeding 2%, to an early tightening cycle that risks dampening economic recovery and prolonging low inflation.

We believe this month might be too early for the BoJ to make further adjustment to its policy stance. Specifically, we forecast the central bank will hold its policy rate at -0.10%. Importantly, we also expect the BoJ to maintain its 10-year Japanese government bond yield target at 0.00%, with a tolerance band of +/- 50 bps. However, we do acknowledge the July meeting is a closer call than usual and will be paying close attention to the BoJ's updated CPI forecasts. Should those forecasts be at, or above, 2% for the next two fiscal years, that could be a signal of an impending policy shift in the months ahead. Indeed, we currently expect the BoJ to make a further tweak to its YCC policy at its October announcement.