The Japanese Yen came under attack last week after having traded within a narrow range for the past 6 months. The dissolution of Parliament by Prime Minister Noda on Friday and the prospect of easier monetary policy from the Bank of Japan drove the Yen to a 6 month low against the U.S. dollar. The Bank of Japan’s monetary policy meeting is currently underway and despite the broad-based and material deterioration in Japan’s economy, the central bank may not ease again. While there is no question that the BoJ needs to do more after recent weakness, they also just increased asset purchases, introduced a new lending program and signed a joint statement with the government to end deflation in October. It takes time for stimulus to work its way down the economy and the BoJ may find it is too soon to ease again especially since they have not seen many October economic reports.

The Bank of Japan is under assault and Governor Shirakawa may choose to go out of his way to assert the central bank’s independence. If the BoJ leaves monetary policy unchanged and makes no mention of future plans, the Yen could rally in relief. However if the BoJ downgrades its economic assessment like many expect and signal plans to ease right before the holidays in December, USD/JPY could extend its slide. Either way, more stimulus is on its way for Japan.

The table at the end of this article shows how the economy has performed since the last monetary policy meeting. There have been some areas of improvement but mostly on the inflation front. Since deflation is a greater risk than inflation, an increase in price pressures won’t remove the BoJ’s need to ease again. Instead, the country’s first current account deficit in 3 decades, larger trade deficit, weaker manufacturing activity and consumer demand are problems that the Japanese government needs to tackle quickly and aggressively.

The main source of Yen weakness is the realistic possibility of a major shift in monetary policy for the BoJ. The dissolution of Parliament by Prime Minister Noda paves the way for a general election on December 16th. On that day, we expect the DPJ to lose majority to the LDP which means former Prime Minister and current LDP leader Shinzo Abe will become the country’s next leader. Abe has been calling for more aggressive measures to boost growth and inflation, starting with the BoJ. He demands the central bank ease aggressively and immediately by targeting a higher level of inflation, lower interest rates on reserves to zero or negative and make unlimited purchases of JGBs. In making these demands, he is effectively stripping away the central bank’s independence, which may infuriate Shirakawa and other monetary policy officials because independence is a right under current BoJ law. Yet it has been a long time since the BoJ has been truly independent and we are seeing tighter involvement of the Japanese government day by day. Economics Minister Maehara’s decision to attend this week’s BoJ meeting is a sign that the government is increasing its pressure on the central bank.

So while the Bank of Japan is expected to hold monetary policy steady this evening, the prospect of a risk of a major shift in monetary policy should keep the Yen weak. In other words, the breakdown in Yen crosses may be here to stay.