Continuing and broad-based yen weakness would sit comfortably with the objectives outlined by Bank of Japan Governor Haruhiko Kuroda in his speech last week at Jackson Hole, Wyoming. The BOJ Governor said the mechanism for negotiating wage increases "stopped working effectively" while Japan battled deflation over the past two decades. He also said he wants to "anchor inflation expectations at 2 percent" to act as a benchmark for wage-setting.
That remains quite a task, and the central bank itself acknowledges that inflation in Japan will slow to around 1 percent in the months ahead. To illustrate the challenge, see this comparative graphic of government bond yields, inflation and interest rates in Japan, the euro zone and Switzerland.
A weak yen, it could be argued, by encouraging imported inflation in a Japanese economy almost entirely dependent on energy imports, has been and remains a key support as the BOJ tries to break long-established deflationary expectations. The central bank has sought to bring to an end a growth-strangling period during which Japanese consumers have put off purchases today in the belief that prices will be lower tomorrow.
Indeed, sources told Reuters on Tuesday that even though the Bank of Japan is expected to cut its economic growth forecast for this fiscal year in a semi-annual review due at the end of October, it is likely to keep its bullish inflation outlook. The aim to cement inflationary expectations is unchanged. But what if the BOJ succeeds?
Traders might wonder how Japan's policymakers can square the circle between anchoring inflation expectations at 2 percent, and the current yield of 0.5 percent on the benchmark 10-year Japanese government bond. Even at very low nominal JGB yields, Japan's debt-servicing costs already consume a substantial chunk of tax revenues.