The Japanese yen is the second largest component of the Dollar Index (DX). It occupies 13.6% of it.
The real interest rate differential is the main reason behind the current severe weakness of the yen. I have already visualized it for you in my earlier post in August.
The Bank of England (GBP, 3rd largest part of DX) and lately the European Central Bank (EUR, the largest component of DX) raised their interest rates significantly during the last meetings. The Bank of Japan (BOJ), the Japanese Central Bank has kept its negative rate of -0.1% since 2016. Moreover, it repeated that it would not hesitate to take extra easing measures if needed, falling out of a global wave of central banks tightening policy.
Why BOJ is so dovish? There are several reasons. One of them, the history of inflation as shown in the chart below.
Japan has had a chronic deflation since the 1990s after the asset bubble burst. We can see how short term spikes of inflation (orange line) into the positive territory were short-lived. The BOJ didn’t even touch the interest rate in spite of inflation that has soared to unseen levels of 3.7% in 2014. This time around, the inflation didn’t race to the same peak and as I wrote above, the BOJ thinks of an opposite – easing!
The BOJ governor Mr. Kuroda said in the summer “If we raise interest rates, the economy will move into a negative direction.” The Japanese Central Bank does not want to cause a recession as the economy is still fragile.
Maybe the next chart could clarify the logic of the BOJ. Continue reading "Where do you think USDJPY will go?"