Bank of America: High oil prices and policy divergence will lead to a weakening of the yen

Investing.com - Bank of America warns that, given Japan’s reliance on Middle Eastern oil, persistently high oil prices will exert significant downside pressure on the yen by pushing up import costs.

The research firm notes that, compared to the Federal Reserve and the European Central Bank, which are traditionally willing to tighten policy to respond to supply shocks, the Bank of Japan’s wait-and-see stance has exacerbated the yen’s weakness.

Although fiscal space is limited, political pressure to implement fiscal stimulus also puts pressure on the yen. A decline in the stock market may prompt funds to reallocate from bonds to stocks, leading to steepening of the Japanese government bond yield curve.

Bank of America states that, considering the impact of further yen depreciation on inflation and politics, it seems unlikely to tolerate unlimited yen depreciation. The expected policy sequence will be first foreign exchange intervention, followed by the Bank of Japan tightening policy.

In an environment of broad dollar strength and high oil prices, foreign exchange intervention carries the risk of ineffectiveness, meaning the intervention threshold will be much higher than USD/JPY at 160. Structural changes have weakened the potential for a yen rebound driven by position unwinding.

Cross pairs like EUR/JPY are still under control, but if oil prices remain high, the risk of accelerated yen depreciation in cross pairs will increase. The firm notes that, while a yen rebound driven by position unwinding cannot be ruled out, structural changes have reduced the likelihood of such appreciation.

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