International | Jul 17 2006
By Chris Shaw
The Bank of Japan (BOJ) surprised no one in the market with its interest rate increase last Friday, but what is surprising is the lack of consensus as to what happens next in terms of both interest rates and the currency.
The consensus opinion, backed up by comments by the BOJ last week as it announced the rate increase, is for further changes in rates to be gradual as the accommodative monetary policy approach is maintained in the medium-term.
Not everyone agrees such an approach will work, as both Danske Bank and Lehman Brothers suggest rather than further increases every six months as is currently expected, the market should be anticipating the BOJ will lift rates every three or four months. Indeed, Lehman Brothers continues to suggest a further increase will be made by the end of 2006 as a follow on to what it saw as a good news hike in that last week’s action gives further support to the "deflation is dead" argument..
It suggests the figures back up its view, pointing out the private sector is again borrowing money for capital investment purposes while the labour market has tightened considerably this year. This combination of factors is expected to make it difficult for the BOJ to keep the rate of increase in interest rates slow, as it shows the underlying economy continues to strengthen.
Danske Bank agrees, while also suggesting waiting a further six months before hiking rates again would give the impression to financial market participants this rate rise was a mistake. It sees the outlook for higher rates as being supportive for the yen in the longer-term but not in the shorter-term as the rate of increase in rates is unlikely to outpace that of Europe or the US, meaning the interest rate differential won’t become smaller.
Nomura Securities agrees with this view, pointing out the interest rate differential between the US and Japan has actually increased slightly of late, suggesting money will continue to flow out of the yen and into the greenback. Nomura is forecasting the yen to weaken to 120 against the US dollar by the end of the year, against a current level of about 116.
Lehman disagrees, as given its more bullish assessment of future interest rate hikes it sees the yen as strengthening against the US dollar. It is forecasting a rate for 2006 of 105, with further gains in 2007 to 95. Such an outcome is unlikely to impress Japanese corporations, who have based their export estimates on a yen-US dollar rate of 110-115 for the current year but would prefer to err on the side of yen weakness rather than yen strength.
