Japanese Yen could see significant movement

Coming Sunday elections will take place in Japan and a few days later the central bank will make a decision on the policy rate. Positions are already being taken on currency markets for a significant movement of the yen.

In the United States, the election battle between Kamala Harris and Donald Trump is reaching boiling point. But the election in Japan this coming Sunday is at least equally exciting. The big question is whether the Liberal Democratic Party (LDP) will manage to stay in power. Earlier this year, the LDP suffered a painful defeat in local elections. The party has been under pressure since a major corruption case came to light. Prominent party members pocketed a portion of the income from the sale of tickets for party events. Several parliamentarians have already been charged and for Prime Minister Fumio Kashida, the scandal in August was a reason not to run for re-election.

Reading between the lines
Kashida was succeeded by Shigeru Ishiba in early October, who quickly called for new elections. According to polls, the LDP is just short of securing a majority in the Lower House. Currently, the party holds 256 of the 465 seats. After a defeat, the LDP does not automatically end up in the opposition benches. There is a very high chance that together with the socially conservative Komeito party, more than half of the seats will be won. Currency markets are eagerly anticipating the economic course that Ishiba will actually take. During his campaign, he remarked that Japan should pursue a normal monetary policy. Traders interpreted this as a signal that the policy rate could be raised.

Investment trick losing its effect
The Bank of Japan (BoJ) had already reduced that rate below zero in early 2016 in the hope of stimulating inflation. Helped by a series of other positive developments, this seems to be working now. In September, inflation reached 2.5%. Earlier this year, the central bank saw room to raise the policy rate by two steps. This was a shock to some market participants. In recent years, some investors have taken advantage of the very low interest rates by borrowing cheap money in Japan and then investing it in other countries for a higher return. If the BoJ raises the rate, this game becomes less effective. Last summer, there was a high demand for yen as parties unwound their positions and repaid the loans.

Elections and interest rate decision Ishiba's victory in the race for the premiership gave the yen a new boost. However, it remains to be seen how he will implement his policies. Because in early October, Ishiba stated that the Japanese economy is not yet ready for a higher rate. Only to indicate a week and a half later that the interest rate policy is a matter for the BoJ. On paper, Ishiba's economic plans are mainly focused on boosting wage growth and investing in rural areas. First, it is a wait-and-see how his LDP stands after the elections. A few days after the elections, the BoJ will already be meeting to discuss the policy rate. The bank is likely to pause, but hedge funds have already positioned themselves for a stronger yen. For now, the Japanese currency is set to face turbulent times in any scenario.

Joost Derks

Joost Derks is a currency specialist at iBanFirst with over twenty years of experience in the foreign exchange market. This column reflects his personal opinion and is not intended as professional (investment) advice.

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