Yen Disappointed by Bank of Japan Caution, But Risk Deterioration Offers Support

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The Japanese Yen fell against the Dollar after the Bank of Japan gave no hint it was prepared to raise interest rates further in the coming months, although a broader deterioration in sentiment is helping this traditional 'safe-haven' against other currencies such as the Pound.

The Dollar-Yen exchange rate rose after the Bank of Japan kept its range for short-term rates unchanged at zero and 0.1%.

It also said it will continue purchasing about JPY 6 trillion of Japanese government bonds per month but will present a plan in July for how it intends to taper off those purchases to reduce its balance sheet.

"The cautious stance on tapering off bond purchases left traders wondering about the central bank’s commitment to further rate cuts later this year," says Shane Strowmatt, an analyst at LGT Private Banking.

The decision to maintain interest rates at current levels is no surprise, and markets were always interested in how the Bank would communicate the next steps and whether it would amend its long-running quantitative easing programme that seeks to keep the cost of borrowing down.

Before the July policy meeting, the BoJ will collect views from market participants about options to reduce JGB purchases.

"By reducing the amount of JGB purchases from the current rate of JPY6tn/mth, the BoJ’s balance sheet will shrink over time. In that way, the BoJ joins other central banks in Quantitative Tightening (QT)," explains Joseph Capurso, an analyst at Commonwealth Bank.

The Yen has been the biggest underperformer in the G10 currency space for more than a year as other central banks raise interest rates and engage QT to fight inflation. These measures also raise bond yields, making them attractive to Japanese investors who can still borrow at near-zero percentage terms.

The subsequent flow of capital means the Yen is sold to fund foreign purchases. However, Yen weakness is a concern for Japanese policy makers and any decision to change interest rates will be because they have an eye on the currency's falling value.

The Bank of Japan has intervened in the currency markets, but only when moves are unruly. With movements being relatively contained of late, the risks of imminent intervention are low and a steady depreciation can continue.

However, we note the Yen is finding some support from a deterioration in global investor sentiment, linked to rising concerns for the French economy and debt markets.

The surprise call for a snap legislative election for the end of the month by President Emmanuel Macron looks to be backfiring as both the left and right have a shot of winning a majority, squeezing Macron's centrist party into oblivion.

The Yen can stay supported against European currencies, the Pound and commodity currencies should this crisis continue to simmer.