JPY falls as BoJ fail to act, but decline should not extend far

GBP retains recent strength as UK CPI comes in in line with expectations

Weak US retail sales unlikely to have much impact

The main focus on Wednesday is on the lack of action at the BoJ meeting. Since the BoJ surprised the market by widening the YCC band in December and allowing 10 year yields to rise to 50bps, there has been speculation of further policy adjustments, helped by some press reports. While few saw any change in the policy rate at this meeting, some anticipated a further widening of the band, while others looked for the target to be shifted to shorter maturities on the curve. One of the main problems for the BoJ is that the widening of the band doesn’t seem to have reduced the need for them to buy JGBs, with several unscheduled buying operations seen in the last month to hold the top of the range. However, the BoJ refused to be bullied into further changes and USD/JPY rallied 2.5 big figures. 

While the BoJ did not change its monetary policy, they did amend rules for fund-supply market operation, which allows the BoJ to offer funds of up to 10 years against collateral for financial institutions. This signals the market their committment in their YCC and loose monetary policy, smashing speculation of an early exit of loose monetary policy. But few believe that the BoJ will be able to run policy in this way indefinitely, and USD/JPY, after initially gaining 2.5 figures has now fallen back below 130 to be only around a figure higher. We do see some potential for a move as high as 132 in the short run if US yields continue their recent recovery, but the big picture view is still for a much lower USD/JPY over the year as eventually we are likely to see some further policy adjustment, most probably when Kuroda leaves in April, while the Fed may moderate their language as the economy weakens and inflation falls. 

UK CPI came in close to expectations, with core just a point higher than consensus at 6.3% y/y while headline was bang on at 10.5%. The drop in the y/y rate from 10.7% was mostly due to lower petrol prices, while food prices inflation continues to accelerate, and is currently running at 16.9% y/y. The data doesn’t contain any real surprises for the Bank of England, and is unlikely to change the market’s current assessment that there is around a 70% chance of a 50bp rate hike at the February MPC meeting. EUR/GBP in nevertheless a little offered after yesterday’s strong labour market data, helped also by the generally stronger risk performance following the BoJ meeting overnight. Nominal yield spreads suggest there is further downside potential for EUR/GBP if risk appetite remains positive, but the GBP picture remains undermined by expectations of weaker data to come, a weak current account picture and historic inflation which has pushed EUR/GBP fair value higher. Even so, the 0.89 level now looks very hard to break near term, and EUR/GBP is likely to explore the centre of the 0.86-0.89 range. 

There will also be interest in the US retail sales and industrial production data, but these are probably not going to impact market expectations of the Fed, which are now firmly set on a 25bp hike in February. Stronger data might consequently prove USD negative if it encourages the equity market. However, we expected the retail sales data to be quite soft, partly due to the exceptionally cold weather.