Bank of Japan Turn Softer

As expected, the Bank of Japan (BoJ), left the leading O/N target rate unchanged at 0.5%. However, the BoJ's tone has turned a little softer, although board governor Fukui stressed at the press briefing that this does not signal a major shift in monetary policy:* For the first time since June the decision to keep interest rates unchanged was unanimous. Apparently super hawk Mizuno now has difficulty in finding arguments for a hike in interest rates.* In its monthly Economic report the BoJ has softened its outlook on the Japanese economy. Its new view is that "Japan's economy is expanding moderately as a trend, although the pace of growth seems to be slowing mainly due to a drop in housing investments." In its November monthly report the BoJ believed the Japanese economy was "expanding moderately" without any qualifications.* At today's press briefing, BoJ board governor Fukui said that "downside risks are increasing slightly" but on the other hand he stressed that the unanimous board vote for an unchanged interest rate and the slightly changed view on the economic outlook should not be seen as a major shift in the BoJ's policy. In reality Fukui maintains a slight tightening bias by saying that "...BoJ will continue to increase interest rates gradually."Although the tone from the BoJ is definitely softer, it has not changed our view on monetary policy in Japan. As we have stressed recently, BoJ in its official statements has been in some denial about the strength of the domestic economy and consequently underestimated downside risks in the Japanese economy. That said, we share the view that current weakness in domestic demand, including construction activity, will most likely prove temporary and domestic demand could possibly rebound strongly in H1 08. However, the softer tone from the BoJ implies there is little risk of a sudden hawkish shift in monetary policy in the short run despite inflation finally creeping into the positive on the back of higher food and oil prices.We maintain our view that the BoJ will remain on hold until September 2008 when we expect it to hike by 25bp. This view is of course dependent on some normalisation of global financial markets. Our view is more hawkish than current market expectations. Markets have reduced their expectation of interest rate hikes in Japan during the recent week (see chart below). The market currently expects only a 10 bp rate increase during the next year.by www.actionforex.com