JPY Forecast Q2 2022: Will Inflation Surpass the Bank of Japan’s Target?

Japanese Yen First Quarter Recap 

During the first three months of 2022, the risk-averse Japanese Yen had a poor record, especially as March came to a close. In line with the rise in S&P 500 and 10-year Treasury yield, the majors-based Japanese Yen Index (JPY/USD/AUD/GBP/EUR) declined.

An increase in stock and bond yields may make it tough for the yen to shine in the Japanese market. At least for the time being, neither Russia's invasion on Ukraine nor a more hawkish Federal Reserve have been able to permanently alter market mood. Is more agony in store for JPY ahead?

How dovish is the Fed likely to be?

At face value, it seems more of the same could remain in store for the Yen in the second quarter. The widening monetary policy divergence between the Bank of Japan and its major counterparts is probably one of the key drivers of JPY weakness. Aside from the Swiss National Bank, the BOJ remains one of the most dovish G10 central banks.

In the first three months of the year, the rates on global government bonds kept rising. Looking at Treasury rates, the 2-year rose from 0.75 percent to above 2.15 percent . As March came to an end, the 10-year yield was just shy of 2.4 percent. A more hawkish Fed was a crucial factor, with policymakers keeping the door open to raise rates in 50bps increments to bring price inflation to heel. By the end of March, the chances of this happening in May had risen to a commanding 75%. 

Will Japanese CPI Surpass 2 percent in the Second Quarter?

Inflation is on the rise around the world, with the exception of Japan, and central banks are reacting. In February, Japan’s headline CPI rate was 0.9 percent y/y compared to 7.9 percent y/y in the United States. In response, the BOJ has done essentially nothing to modify monetary policy. The target policy balance rate has stayed at -0.10 percent , alongside a 0 percent “yield curve control” (YCC) restriction on the 10-year JGB bond yield. Will this change?

Crude oil and coal briquettes are two of the most important imports into Japan. Russia’s invasion on Ukraine has driven the prices of these crucial supplies rising as the developed world looked increasingly to other sources. In reality, as Japan is a big energy importer, rising costs may have had a part in the Yen’s devaluation.

On the chart below, I have estimated where Japan’s headline CPI (YoY) rate could go from here. This is based on a multiple linear regression model that assesses the impact of crude oil and coal futures on the country’s inflation since 2015. Since CPI tends to trail prices, I’ve delayed the latter by 8 months compared to CPI. This means we may use recent oil and coal prices to estimate inflation in the years ahead.

As predicted by the model, Japan's y/y headline inflation rate could rise to more than 2% in May. Is the central bank likely to modify policy when it happens? Probably not. Before shifting course, the BOJ may wait for evidence of consistently high CPI statistics. Even when inflation rose briefly above the central bank's objective, it did nothing. Absent a market disaster, the path ahead for the Yen is likely to remain challenging.

Projection of Inflation in Japan