Asia Perspectives - BoJ stays on hold in March as Middle East conflict add uncertainties to policy normalisation outlook

Highlights: In-line with market expectations, the Bank of Japan (BoJ) left policy rate unchanged in today’s March meeting, with the central bank reiterating its long-held message that it will continue to raise rates and adjust the degree of monetary accommodation if its economic outlook is realised. However, the evolving situation in the Middle East as well as developments in crude oil prices present new uncertainties. Our base case remains that the BoJ delivers a single 25bp rate hike this year, most likely at the July meeting, taking the policy rate to 1.00 per cent. That said, if the energy shock persists and feeds into inflation expectations, especially alongside JPY weakness, the probability of an earlier rate rise (or additional hikes) may increase. 

• JPY (Neutral): With uncertainties on the BoJ’s policy normalisation timeline, we still expect there could be swings for JPY, with more risk to the weaker side. We see USDJPY staying elevated at around 160 in H1 before moderating to end the year at 155. For the JPY to stage a more sustainable recovery, we think it will require supportive flow measures, a more proactive BoJ, and greater fiscal discipline
• JGBs (Neutral): Under the leadership of Takaichi, Japan has undertaken material fiscal expansion. Nevertheless, the country continues to maintain the smallest fiscal deficit among G7 nations. It appears that the impact of fiscal expansion is already reflected in the JGB term premium, particularly at the medium to long end of the yield curve. JGB yields trended up across all tenors after today’s BoJ meeting as the market perceives that the BoJ will still have a hawkish tilt amid imported inflation risks. We maintain our neutral stance
• Japanese equities (Overweight): The Japanese stock market has seen profit taking and foreign outflows after the commencement of the Iran conflict given concerns on the nation as a heavy oil importer, and has corrected 8 per cent month-to-date. That said, it is still up 6 per cent year-to-date. We believe Japan can see a further domestically driven re-rating of its stock market. We expect the new PM’s agenda to boost policy stimulus, which should help both economic activity and valuation multiples. Corporate governance reform is another plus for investors as it boosts ROE, and we believe this process will continue