TOKYO -- Monetary policy looks to dominate currency markets this week, with the yen likely to strengthen should the Bank of Japan signal a move away from its ultra-accommodative stance.
The BOJ adopted its yield curve controls in September 2016 to guide long-term interest rates around zero, and has remained steadfast on the policy ever since. Meanwhile, the U.S. Federal Reserve continues to steadily raise rates, with the European Central Bank also tightening monetary policy albeit at a slower pace.
Reports on July 20 that Japan's central bank was considering a more flexible approach to its targeting of long-term interest rates sparked speculation that a shift might be in the offing. The speculation pushed the yield on benchmark newly issued 10-year Japanese government bonds above 0.1% for the first time in a year, and the yen has appreciated against the dollar as well.
The BOJ policy board will convene for a two-day meeting starting Monday to discuss how to handle the side effects of the central bank's massive, yearslong easing program, including declining bank earnings and distortions in stock and bond pricing. Its response to these issues could rattle markets.
If the BOJ "does something like raise the level of long-term rates, the yen will strengthen," said Daisuke Karakama of Mizuho Bank. "There's no way" the central bank could take that route, Karakama said.
Yuji Saito of Credit Agricole Corporate and Investment Bank also expects no rate hike. The bank "will probably start researching how to continue easing for longer while being mindful of the side effects," he said. But Saito thinks investors will remain conscious of the possibility of a future policy shift, discouraging selling of the yen.
Some analysts say the central bank may lift long-term rates to address the negative effects of easing, while conducting bond-buying operations as needed. In this case, Karakama sees the yen strengthening beyond 110 against the dollar.
Yet Akira Moroga of Aozora Bank expects the Japanese currency to level off around the 110 mark under this scenario. "The market is already pricing it in to some extent," Moroga said.
The Federal Reserve's steady rate hikes have widened the gap between American interest rates and those in Japan and Europe, though the ECB has begun to edge toward tightening as well.
The ECB's governing council on Thursday reaffirmed plans to gradually taper its bond-buying program but keep interest rates at their current ultralow levels until at least next summer. The decision to stand pat touched off a drop in the euro against the dollar.
The U.S. Federal Open Market Committee meets this week as well. The Fed raised rates at last month's meeting, and its median monetary policy forecast now calls for four hikes this year, up from three in March.
"The FOMC believes that -- for now -- the best way forward is to keep gradually raising the federal funds rate," Chairman Jerome Powell said in his semiannual testimony before Congress this month.