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Wednesday August 22, 2007 - 13:01:57 GMT
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FX Thoughts – BOJ Unlikely to Hike

The 2-day Bank of Japan meeting is already underway, in what is probably the biggest BOJ meeting since the end of ZIRP (Zero Interest Rate Policy) back in July-2006. This BOJ meeting is most likely to be the first casualty of the current problems in the credit markets in the US, as the BOJ, which was widely expected to hike rates by 25 basis points just 15 days back, is now expected to hold their rates at the existing level of 0.50%.

The last rate hike by the BOJ was back in Feb-2007 by 25 bps, which was its second hike since 2001. The economic data out of Japan since that rate hike has been nothing other than very disappointing. The Japanese Inflation (CPI) has so far recorded a figure of below 0.0% every month in the year, indication that the decade old deflation is not run through yet. Infact last month’s CPI (m/m) data was -0.2%, the worst in over four months.

The Japanese growth indicators are not too good either, which was seen when the Apr-June GDP grew by 0.1% (q/q) against 0.8% in the previous quarter. The annualized growth was 0.5% compared to a growth of 3.2% in the same period.

Adding to the current concerns is the sharp rally in the YEN, which has gained against the USD. Importantly the Yen has gained against all its major crosses against EUR, CHF, AUD, NZD, CAD, and GBP. A sharp fall in the Nikkei-225 over the last few days is not likely to help any rate hike expectations. Last Friday, N-225 had its biggest intraday fall in over five years.

The Japanese govt bonds (JGB’s) interestingly had started pricing in a “No Hike” back from July itself as the 10-Year JGB yield topped out at 1.96%, near its big historical Resistance of 2.0%. The 10-Y yield is currently at 1.60% and that means that the yields have declined by 19% since 10-July top. See the 2007 chart of the Japanese 10-Year Bonds given below.

With a “No Hike” almost a certainty, the markets would be closely watching the Fukui press conference to gauge on his assessment on the impact on Japan and its banking system of the current Sub-prime and credit markets rout in the US. The markets would also like to know about Fukui view on when BOJ would be expected to hike next. If Fukui sounds hawkish, then there may be rate hikes later on in the year, while a dovish Fukui could see markets discounting no further hikes in 2007.

JPY is unlikely to be big beneficiary in case of a no hike, however it is also unlikely to be a big looser as well, as these are already priced in. The JPY is more driven by risk aversion there currently. In case of a surprise hike, the JPY is likely to gain big time, with a fresh round of carry unwinding across all its crosses.

Technically USD-JPY is in a long-term downtrend and has an important Resistance near 116.80-117.00. While below that the pair is likely to stay pressured and additional downside and at least a retest of recent lows of 111.78 may be seen in the next few days. The immediate Resistance is at 115.50. Rally should be used to sell the pair.

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