Japanese policymakers have sought to limit the speed and extent of the yen’s recent depreciation. But, with the interest rate differential between the US and Japan so wide, the impact of currency market interventions has typically been swamped by economic fundamentals, notably in the US.

Most recently, softer nominal growth in the US, a safe-haven bid and expectations of further Bank of Japan (BoJ) monetary tightening – including tapering its asset purchases – have helped support the currency.

The BoJ owns around 50% of outstanding Japanese government bonds (JGBs), so the path back to investor-driven price discovery may be bumpy. Indeed, tapering the BoJ’s asset purchases could have international spillovers, with other overseas bond yields moving higher and Japanese investors selling out of various overseas assets to purchase JGBs.

But the BoJ is aware of the risks and is consulting with market participants on the path for asset purchases. It will try to ensure the pace of tapering is gradual.

Moreover, with Japan’s exit from deflation only half convincing and activity and inflation data mixed, domestic economic conditions also argue for only a gradual tightening in financial conditions.

 We expect the BoJ to announce that the monthly pace of JGB purchases will initially fall from Y6 trillion to Y4- 5 trillion. We also think a July rate hike is possible and expect policy rates to be at 0.2%-0.3% by year-end. 

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