BoJ stays on hold, GBP keeps plunging

Summary:

• Bank of Japan kept monetary policy settings unchanged and slashed inflation and GDP forecasts
• British pound keeps plummeting on the news Borish Johnson may not Brexit restart talks with EU leaders
• Mexican President signals rates are too low for a slowing economy

Stand pat

The Bank of Japan kept its all monetary policy settings unchanged during the meeting in July while slashing inflation and economic growth forecasts, a decision widely expected by analysts. First of all, the BoJ maintained its yield curve control program and asset purchases. As a result, the Bank has still a target of increasing JGB holdings by roughly 80 trillion JPY per year and ETF holdings by about 6 trillion per year, however, actual purchases vary quite widely from month to month as these purchases are secondary to controlling interest rates. In terms of forward guidance, the BoJ left its pledge to keep rates at the current extremely low level through at least spring 2020. Do notice that some analysts had expected the BoJ to strengthen this pledge to avoid unwanted JPY appreciation. Meanwhile, the yen has risen in response to the BoJ decision, however, the reaction has not been substantial as it is rising 0.15% against the US dollar at the time of writing. On top of that, the BoJ decided to cut inflation and GDP forecasts and now it sees the economy expanding 0.7% YoY in the current fiscal year (down from 0.8%), 0.9% in the FY 2020 and 1.1% in the FY 2021 (down from 1.2%). In turn, core price growth is to be 1% this year (down from 1.1%), 1.3% in the following year (down from 1.4%) and 1.6% in the FY 2021. In our view, even as the yen has yet to strongly respond to today’s BoJ decision we think it may still experience some appreciation if the Fed cuts rates tomorrow and hints at even more such moves in the foreseeable future - that poses an upside risk for the JPY. Let us remind that Haruhiko Kuroda said in June that big stimulus moves were still possible.

The USDJPY has been trapped in a narrow range since the beginning of June. The further direction will depend on what the Federal Reserve will do. Source: xStation5

Pound bleeds

The British pound is by far the worst performing major currency this morning being down more than 0.7% against the greenback. This has come following the news that new Prime Minister Boris Johnson will not start Brexit talks with European Union leaders unless they first agree to his demand to reopen the divorce deal they struck with his predecessor Theresa May, Bloomberg reports. GBP’s strength was already seen on Monday with the FTSE 100 surging 1.8% on expectations that the weaker currency could boost companies’ earnings. Now, having Johnson at the helm of the British government it looks like a no-deal scenario has become much more likely, that is what markets do not like. Let us remind that the United Kingdom is set to leave the European Union on October 31. As a result, the pound could remain under severe downward pressure until then in spite of the fact that it remains well below its long-term fair value based on the real effective exchange rate.

The GBPUSD seems to be poised to test post-Brexit lows set below 1.21. Source: xStation5

In the other news:

• Mexican President Lopez Obrador said that rates are too low for a slowing economy, though adding that he respects the central bank’s freedom to set rate independently 

• Japanese industrial output fell in June by 3.6% MoM, the jobless rate fell to 2.3% from 2.4%, while the job-to-applicant ratio ticked down to 1.61 from 1.62

• French economy grew 0.2% QoQ in the three months through June, missing the median Bloomberg estimate of a 0.3% QoQ increase