Unstable global financial conditions and the BOJ

BoJ is likely to stay on hold and unlikely to significantly change its optimistic growth and inflation outlook. But, BoJ's assessment of external risks will be closely watched, especially if risk sentiment deteriorates prior to meeting, absent a shock to FX market, Kuroda should maintain its neutral tone on JPY. The BOJ will hold a Monetary Policy Board meeting on 14-15 July. It believed Boj will adhere to its current monetary policy framework, including the amounts and residual maturities of its bond purchases. The BOJ will issue an interim assessment of its Outlook for Economic Activity and Prices at this meeting, and based on the last three months of data, we believe it is unlikely to significantly change the optimistic economic and inflation forecasts in the Outlook report released in April, says BofA Merrill Lynch.

A snapshot of the economy based on BOJ's June Tankan survey and major data for April/May shows improvements in three areas: capex, consumption, and inflation. And risks include high inventory levels (mainly for consumer durables), and weak export volume due to China's economic slowdown. Based on this, it is expected that, BOJ might slightly upgrade its outlook for domestic demand and slightly raise warning on downside risks to external demand.

The BOJ might trim its growth forecast to account for a weaker export trend. But, no significant change in the overall picture of its forecast that Japan's economy would achieve above-potential growth this year. With regard to inflation, exchange rates are roughly flat and oil prices have fallen back somewhat relative to 30 April, when the Outlook report was released. The market will be watching whether the BOJ reflects the resumption of oil price decline in its inflation outlook. But even if it does so, it is expected the revision to be material this time around, notes BofA Merrill Lynch.