BOJ Preview: Still on hold, but for how long?

• The Bank of Japan will likely maintain its monetary policy unchanged, but tapering is not far away.
• Japanese inflation surged above 2% YoY in May for a second consecutive month.
• USD/JPY remains near a multi-decade high and may extend its rally to 140.00.

The Bank of Japan will announce its monetary policy decision on Thursday, July 21. The central bank is one of the last to maintain its ultra-loose monetary policy and seems to be in no rush to hike rates. Governor Haruhiko Kuroda warned of "very high uncertainty" over the economic outlook just last week and repeated the central bank is ready to ramp up stimulus as needed to underpin a fragile recovery.

Still on-hold

Kuroda, whose term ends next April, can afford an accommodative monetary policy as Japan has avoided rampant inflation. On the contrary, the country has spent decades struggling with deflation. According to the latest official figures, the annual inflation rate stood at 2.5% in May, its highest in over seven years and above the BOJ’s 2% target for a second consecutive month.

Interest rates turned negative in 2016 and are expected to remain set at -0.10%. Japanese policymakers will also maintain the yield curve control, with an upper limit of 0.25% for the 10-year bond yield. The central bank will also publish its quarterly outlook report, with updates on inflation and growth forecasts.

Wage growth remains subdued in the country, another reason for the BOJ to stick to its ultra-loose monetary policy stance, as sustained wage growth should help engender healthy inflation levels.

Central banks’ imbalances

Meanwhile, over 75 central banks from around the world have begun tightening their monetary policies. The US Federal Reserve is among the most aggressive, and speculation mounts that it could pull the trigger by 100 bps in their meeting next week after hiking 75 bps early in June. The Japanese yen has weakened against its American rival to its lowest level in over twenty years. So far, policymakers have refrained from doing more than the usual jawboning of “watching carefully” the exchange rate.

USD/JPY possible reactions

The USD/JPY pair has little chances of turning volatile, as the decision is already priced in. Policymakers may hint at tightening, although not in the near term. If the BOJ is set to change its monetary policy, it will likely be in the last quarter of the year. Nevertheless, a heads up could be enough to boost the local currency and push USD/JPY firmly down.

In risk-averse scenarios, demand for the dollar has outpaced that of its Japanese rival. The possibility of a bullish run will likely be linked to the market sentiment rather than any potential central bank announcement.

A strong static support level and a possible bearish target is the 137.00 figure, with a break below it hinting at a bearish continuation that could extend towards the 134.70/135.00 price zone in the next few days. On the other hand, if the pair manages to run past 139.38, a test of the 140.00 threshold is on the cards.