Referred to as the ‘Japanese post-war economic miracle’, in the three decades following 1960, Japan underwent rapid economic growth.
With average growth rates of 10% in the 1960s, 5% in the 1970s, and 4% in the 1980s, the Land of the Rising Sun established itself as the world’s second-largest economy until 2010, before being surpassed by the People’s Republic of China. By 1990, income per capita in Japan equaled or surpassed that in most countries in the West.
After facing years of deflation over the past decade, in 2013 Japan’s government pledged to revitalize inflation while relying heavily on the Bank of Japan to contribute to both the maintenance of stability of the financial system and to the sound development of the national economy.
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What is the Bank of Japan?
The Bank of Japan (BoJ) is Japan’s central bank and the country’s highest monetary authority. The bank is headquartered in Nihonbashi, the business district of Chūō, Tokyo. It was established under the 1882 Bank of Japan Act and began operating on October 10, 1882, before issuing its first currency notes in 1885.
In order to accomplish its duties as the central bank, the BoJ has a head office, 32 branches, and 14 local offices nationwide and seven overseas representative offices.
As the central bank of the third-largest economy in the world, the Bank of Japan has a direct impact on the foreign exchange market.
Therefore, one of the most important events to follow for anyone with an interest in the forex market is the periodic BoJ meeting, where the official Japan monetary policy is chosen in response to current economic developments.
How Does the Bank of Japan Work?
As Japan’s premier monetary and financial institution, the BoJ’s main mission is to ensure the stability of the value of money, both internally (stability of prices) and externally (foreign exchange rate), as well as the stability of financial systems to ensure the trustworthiness of money as a means to settle economic transactions.
To fulfill these missions, the BoJ conducts the following activities:
- Issuance and management of banknotes
- Formulation and implementation of monetary policy, most notably the adjustment of the Bank of Japan interest rate
- Providing settlement services among banks and other financial institutions
- Acting as the nation’s bank of banks, monitoring and examining financial and management conditions of financial institutions and serving as lender of last resort
- Conduct of treasury and government securities-related operations
- Engaging in international activities such as providing yen accounts to central banks and governmental institutions overseas, intervening in foreign exchange markets and participating in an international exchange of views; and
- Compilation of data, economic analyses and research activities
Structure of the Bank of Japan
The organizational structure of the bank is established based on the Bank of Japan Act, by-laws, and other internal rules. The bank’s officers include the Governor, (Haruhiko Kuroda, since 2013), the Deputy Governors, Members of the Policy Board, Auditors, Executive Directors, and Counsellors.
The Policy Board, the bank’s highest decision-making body, is made up of nine members: the Governor, two Deputy Governors, and six Members of the Policy Board.
Japan monetary policy decisions are made by a majority vote of the nine members of the Policy Board, which determines the guideline for currency and monetary control, sets the basic principles for carrying out the bank’s operations and oversees the fulfillment of the duties of the bank’s officers, excluding Auditors and Counsellors.
The role of the Governor is to represent the bank and to exercise general control over the bank’s business operations in accordance with decisions made by the Policy Board. Hence, the Governor of the Bank of Japan has considerable influence on the economic policy of the Japanese government.
Functions of the Bank of Japan
As the central bank of Japan, the bank conducts various business operations, including the provision of cash, and of payment and settlement services; conduct of monetary policy; ensuring of financial system stability; and provision of government-related services.
The Bank of Japan Act states that the bank’s monetary policy should be “aimed at achieving price stability, thereby contributing to the sound development of the national economy”. On this basis, the Bank set the “price stability target” at 2 per cent in terms of the year-on-year rate of change in the consumer price index (CPI).
In the event that the inflation levels are off target, the bank can intervene using tools which may include interest rates, yield curve control, money market operations, minimum reserve requirements, buying massive quantities of Japanese stocks, quantitative easing and others.
For example, when the Bank of Japan issued a quantitative easing (QE) programme in April 2013 with the goal of stimulating consumer spending to boost inflation, it pumped a huge amount of money into Japan’s economy.
With regard to the autonomy of the BoJ, the Bank’s monetary policy independence is secured under The Bank of Japan Act.
At the same time, to ensure that the Bank’s monetary policy and the basic stance of the government’s economic policy are compatible, the Act stipulates that the Bank shall always maintain close contact with the government and exchange views sufficiently. However, the government representatives have no votes in the monetary policy decision.
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The Bank of Japan in Fundamental Analysis
The influence of the BoJ on the economy of Japan is based mostly on the Bank of Japan interest rate and other economic interventions by the Policy Board at Monetary Policy Meetings (MPMs), held eight times a year for two days.
At each BoJ meeting, the Policy Board discusses the nation’s economic and financial condition and establishes the guidelines for money market operations and the bank’s monetary policy stance for the intermeeting period. In return, this will often affect the value of the yen and how it interacts with other global currencies.
As historical interest rates have shown, the BoJ rarely adjusts interest rates unexpectedly. In the rare event that this happens, the adjusted BoJ rates should create huge market volatility.
BoJ Interest Rate Hike
As a rule of thumb, when the economy is expanding or growing too fast, the Bank of Japan may start a tightening cycle to control spending and mitigate rising inflation, as it can create a bubble and lead to future economic stability problems.
In this event, the BoJ can decide to raise the interest rates, as higher interest rates mean people will borrow less and spend less, by this slowing down or even reducing the inflation.
Here, the JPY is expected to appreciate against other currencies, government bonds will rise, while stocks and indices traded on the Tokyo Stock Exchange, such as the Nikkei 225, will drop as investors tend to redirect their capital away from riskier assets.
BoJ Interest Rate Cut
The opposite is true as well: when an economy is shrinking, the monetary policy may loosen in order to stimulate the economy.
In this case, the BoJ can decide to decrease the interest rates, as lower interest rates will theoretically motivate people to borrow and therefore spend, in addition to encouraging businesses to make more investments and increase employment, resulting in a boost of the economy.
Here, the JPY and government bonds are expected to depreciate, while stocks and indices traded on the Tokyo Stock Exchange will rise, as the profitability of many companies would be expected to increase, while investors would be tempted to return to investing in riskier assets with the goal of achieving higher gains.
How to Trade with the Bank of Japan Decisions?
Trading the news and events surrounding the BoJ meeting is always exciting and can be potentially beneficial for traders.
Following the content of the MPM’s decisions on monetary policy, such as the guideline for money market operations, in addition to its views on economic and financial developments can project an economic outlook and offers clues whether the BoJ will cut interest rates, increase interest rates or maintain them.
For example, positive economic news can indicate an upcoming increase in interest rates, resulting in a strengthening JPY.
If the news is negative, the opposite may happen, meaning we may expect a decrease in interest rates, leading to a weakening JPY.
Consequently, a higher than expected rate is considered positive/bullish for the JPY, while a lower than expected rate is considered negative/bearish for the JPY.
Many traders base their positions on the MPM announcements. Moreover, knowing when the upcoming BoJ meeting is scheduled to occur allows to plan a trading strategy and prepare in advance for the volatility that will almost certainly surround the event.
But even in situations when interest rates remain unchanged, the anticipation surrounding important events like the BoJ meeting often have a major effect on the market.
Therefore, as traders, it is important to realize that the Japan monetary policy carried out by the BoJ is one of the most important factors affecting various types of assets on a fundamental level, hence creating potentially superb trading opportunities. These include the yen and its paired global currencies, government bonds, local equities and indices and other securities.
Now that you know more about the Bank of Japan and its influence on various trading instruments, it is important that you follow fundamental news and above all changes in monetary policy by keeping track of the next BoJ meeting on the economic calendar.
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