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BoJ Interest Rate Analysis

Written by A Forex View From Afar on Thursday, January 22, 2009

In the early hours of Thursday, the BoJ released its 2009 and 2010 updated forecast in the monetary policy statement that followed the interest rate decision.

The members of the policy board estimated that the economy will contract by 2.0% in 2009, even though the initial forecast, dating back to October of last year indicated a 0.6% expansion. The 2010 forecast was also revised lower, from 0.1% in October to -1.8% now. However, the policy board expects the GDP to pick up again in 2010, having the economy expand by 1.5%.

The bank has also shifted lower its inflationary view. The bank estimates the CPI read will show deflation in 2009. The bank expects the CPI to come down to -1.1% in 2009, from the estimated number of 0% in October. In addition, the bank also expects the CPI to remain under the 0% benchmark in 2010.

The BoJ issued a very downbeat forecast, which shows that the Japanese economy will again face deflation, something that the bank has tried to fight for years and never succeeded. In all probability, the central bank will try again to implement a quantitative easing approach, buying a wide array of debt instruments to bring yields down.

Most likely, the BoJ will focus on corporate debt to bring yields down, making it easy for the corporate environment to borrow and access liquidity. At the same time, these measures will drastically expand the monetary base, adding inflationary pressures (even though this has never succeeded in practice by the bank).

Furthermore, in order to shift to the upside the inflationary expectations, the bank will be temped to intervene in the currency market, as it has done before. In the past few weeks, top Japanese officials complained about the yen’s strength, and said an intervention is very likely. This is no surprise, since yesterday the yen reached a 13-year low against the dollar, choking exports.

Usually, central banks disappoint very rarely, and are committed to what they say and preach. In the medium to long term, expect strong yen rallies on positive U.S. future numbers, and some unusual resilience to break lower, on negative equity markets.

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