SPECIAL REPORT: Ahead of BoJ October

*BoJ unlikely to lower key policy rates in Oct.
*But likely to keep door open for additional easing in the future
*Odds for no change leaning 64-36

When?

The BoJ's meeting and policy rate decision is due to be released sometime on Thursday, October 31. As a reminder, BoJ will likely want to digest the market reaction to the Fed's decision - taking place earlier on that day at 5am AEDT - before making its own.

What we expect?

Building on our SPECIAL REPORT: Ahead of BoJ September we feel the Bank of Japan's (BoJ) inclination, as some members noted earlier in the month, is to save its monetary bullets for the potential occurrence of negative economic shocks down the road. Especially since risk assets have broadly rallied in October driven by a lull in negative US-China trade headlines which seems to be moving in the right direction.

As it stands, we think the most likely outcome is for the BoJ to keep its main policy rates (short-term policy target -0.10%, 10y yield target 0.00%) unchanged in line with market expectations, but also maintain investor expectations for additional future easing as to not significantly impact USDJPY. Markets are currently implying a 65% probability that the BoJ hold, and therefore, a 35% chance that the BoJ cut.

USDJPY (Green, LHS). Japan's 10y yield (Orange, RHS). Source: Eikon

Reasons for policy hold

With major concerns about the negative impacts of ultra-loose monetary policy and going further into negative territory, we believe the BoJ will not want to cut rates unless it absolutely must. Another rate cut from -0.01% to -0.02% makes Japanese investments less attractive than they already are and heightens the need for increased funding provisions to Japanese banks, like unconventional actions the ECB undertakes.

Furthermore, broader thematic risks have subsided somewhat over the past month with both US-China trade talks and Brexit seeing mostly positive headlines. This has led to sizable Yen depreciation with risk-on/risk-off proxy USDJPY driven close to multi-month highs of 109. The elevated status of USDJPY means the BoJ won't be urged to depreciate the Yen (by lowering rates) in order to protect the economy from the unfavourable effects of a stronger Yen. If USDJPY were to fall below 104 and surpass August lows, then that might push BoJ to reconsider its immediate stance.

What else can the BoJ do?

Outside of lowering rates, the BoJ could target longer-term yields (20y, 30y), deliver more ETF purchases and extend forward guidance introduced recently. We think the possibilities of these won't draw much focus this time round but should play a part going forward as unconventional measures in which the BoJ stimulates the economy.

Reaction

1. Most likely: rate hold with dovish future intentions and no changes to additional measures. USDJPY marginally bearish or unchanged. Nikkei Futures softer. Lower volatility outcome.

2. Less likely: 10bps rate cut with additional measures.
USDJPY bullish. Nikkei Futures bullish. Japanese bank stocks bullish. Higher volatility outcome.

3. Less likely: 10bps rate cut with no additional measures and neutral outlook.
USDJPY bullish. Nikkei Futures bullish. Japanese bank stocks bearish. Higher volatility outcome.

USDJPY pivot levels.
Upside: 109.31, 109.92-94, 110.64-67
Downside: 107.54-57, 106.51, 104.45