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Europe set for lower open as Bank of Japan stuns markets with unexpected policy settings tweak

Governor Kuroda of the Bank of Japan

European markets saw a modestly positive start to the week yesterday in what looked set to be a fairly quiet week, as we head into the dying embers of a year that has seen some significant volatility and weakness.

US markets on the other hand fell back sharply as rising yields acted as a major drag on the tech sector especially, with the Nasdaq 100 leading the losses. Once again it appears that uncertainty over the Fed’s rate path next year is keeping most people on the side-lines, as investors draw a line under their 2022 portfolios.

Asia markets have also plunged after this morning’s surprise move by the Bank of Japan to tweak its monetary policy settings by widening the band on its yield curve control policy by 25bps.

Even before this morning’s events it seemed improbable given the uncertain rate backdrop that we were likely to get any sort of so-called Santa rally this late in the day. The reality is that anyone who’s made any money this year will be content to hang onto their winnings, while the rest are unlikely to want to compound their 2022 misery with more potential losses. Consequently, we can expect to see European markets open sharply lower in the wake of this morning surprise move by the Bank of Japan to tweak its yield curve control settings.

Today the Bank of Japan completed the cycle of central bank rate decisions over the past week with its latest policy meeting and a surprise decision to widen the band of its yield curve control to between -0.5% and +0.5%, from +/-0.25% sending the yen surging in a move that caught the markets completely off balance. The recent weakening of the US dollar had been a welcome boost for the BoJ and had put the Japanese yen beyond the previous intervention levels of just below 150.00 meaning that Japanese policymakers were expected to be much more relaxed about where the yen is, than they were two months ago.

Some of the recent yen strength had also come about because of some mutterings that the BoJ might start to look at changing its current policy on yield curve control now that national CPI had moved up to 3.7%, and its highest level in 8 years, however there was little indication that the central bank was inclined to alter its policy settings so soon, and at a time when market activity tends to be thinner than normal.

It was only at the weekend that reports emerged that new PM Kishida was looking at tweaking the central bank's mandate when incumbent governor Kuroda steps down in April saw the Japanese yen briefly surge, before the reports were denied by the Japanese government in a move that wasn’t altogether surprising. Even if they were thinking along those lines, they are unlikely to confirm the reports this far in advance.

The timing of this morning’s move is even more surprising given that while a move was expected at some point, with most expecting a move in the early part of next year, there was a general feeling that policymakers wanted to be more certain that the recent move higher in inflation isn’t as temporary as it was back in 2014, when inflation was at similar levels.

It also suggests that the Bank of Japan is starting to become concerned about policy lags and inflation becoming more entrenched. It also gives them more flexibility in 2023 in the event they need to start applying the brakes to prevent a significant overshoot in inflation, with the potential that we could see a rate hike before the end of next year.   

EUR/USD – posted a potential key day reversal last week, after pushing up to 1.0735. This keeps onus towards the downside with support at the 1.0520 area, with further support at 1.0330/40.

GBP/USD – saw a bearish reversal on cable last week after failing at 1.2450. We currently are finding support at the 200-day SMA at 1.2110, with a break below the 1.2100 area potentially opening the 1.2000 area. Currently have resistance at the 1.2280 area.

EUR/GBP – currently seeing resistance at the 0.8770/80 area, with a break targeting the 0.8830 area. Support currently at the 200-day SMA with a break below 0.8540 opening up further losses towards 0.8480.

USD/JPY – plunged below the 200-day SMA at 135.70 opening up a sharp move lower towards 130.00.  Currently have resistance at the 138.00 area, with a break potentially retargeting 140.00. A concerted break below 200-day SMA retargets the lows at 133.60.

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