Bank of Japan undermines yen

The decision to leave interest rates at 0.25% will maintain the risk of yen selling on yield grounds. There will be the risk of yen losses towards 122.0 in the short term before a potentially sharp correction.

The yen weakened to lows around 120.85 against the dollar on Wednesday before regaining some ground later in US trading ahead of the Bank of Japan decision. The yen came under fresh pressure after the Bank of Japan interest rate decision with a move beyond 121.0.

The Bank of Japan left interest rates at 0.25% following the latest policy meeting. There was, however, a split decision with a 6-3 vote for unchanged rates, the tightest vote for three years. There will be a strong suspicion that the bank bowed to political pressure in the decision to leave rates on hold and this will undermine Bank of Japan credibility. The loss of credibility, allied with the very low level of yields, will maintain the strong temptation to sell the yen on yield grounds, especially as underlying confidence in the currency and domestic policymakers will be damaged. In the testimony after the decision, there was no clear commitment to a February increase from Bank of Japan governor Fukui and the statement will reinforce negative yen sentiment.

The comments from finance officials will be watched closely in the short term. There will also be political pressure for yen losses to be curbed given the underlying trade stresses and there will be some risks of co-ordinated verbal intervention to prevent aggressive yen selling.