Synopsis:

Credit Agricole suggests that the upcoming Bank of Japan (BoJ) meeting will be the pivotal event for the Japanese Yen (JPY) in the near term. Despite the likelihood of the BoJ updating its inflation forecasts again and projecting inflation to surpass its 2% target for three consecutive years, the central bank is anticipated to leave its policy rate unchanged. The BoJ will utilize a blend of energy subsidies and import inflation reduction to mitigate the effects of rising energy costs. The market is speculating on possible adjustments to the Yield Curve Control (YCC), and if this materializes, it could provide the JPY with a notable uplift.

Key Points:

1. BoJ Meeting Anticipation:

   • The BoJ is expected to keep its policy rate stable, even as it probably revises up its inflation forecasts.
   • The BoJ's approach would be centered on providing energy subsidies and curbing imported inflation by restricting JPY downside.

2. YCC Speculations:

   • Market players are contemplating potential refinements to the BoJ's YCC.
   • The upward movement in the 10-year US Treasury (UST) yield towards 5% and Japan's new economic stimulus package indicates that the 10-year Japanese Government Bond (JGB) yield's macro fair value is nearing the BoJ's 1% cap, which was set in July.

3. Implications of YCC Changes:

   • According to Credit Agricole's Japan economists, the aforementioned dynamics could compel the BoJ to elevate its 10-year JGB yield cap in the imminent meeting or possibly in December.
   • This potential alteration would enhance the sustainability of the YCC framework by decreasing the BoJ's JGB acquisitions without necessarily signifying monetary tightening.
   • If the BoJ increases the 10-year JGB yield cap, the JPY stands to benefit significantly.

4. Projected Impact on USD/JPY:

   • Credit Agricole's FAST FX model indicates that, based on current 2-year and 10-year UST yields, elevating the 10-year JGB yield cap to 1.25% could bring the USD/JPY's short-term fair value down to 146.20 from the existing estimate of approximately 149.40, assuming the 10-year JGB surges to 1.25% and the 10-year UST yield remains around 5%.

Conclusion: The BoJ's policy meeting holds significant implications for the JPY. Should the BoJ opt for modifications to the YCC, this could drive substantial shifts in the JPY's valuation against major counterparts. The current market sentiment appears tilted towards such potential changes, with many investors keenly watching the BoJ's decisions in the coming days.