Goldman Sachs USD/JPY forecasts unchanged

Japanese Yen: FX Forecasts: We maintain our USD/JPY forecasts of 122, 125 and 130 in 3, 6 and 12 months. This implies EUR/Â¥ at 127, 125 and 124 in 3, 6 and 12 months.

From Goldman Sachs:

Motivation for Our FX View: The BoJ surprised the market by introducing a negative interest rate at its January 2016 meeting. This will augment the Bank's ongoing QQE programme, which is increasing the monetary base by JPY80trn per year. A negative interest rate is a significant regime break for the BoJ, and at the same time it was keen to stress that the negative rate is not a substitute for additional asset purchases, but rather a third prong - in addition to quantitative and qualitative easing - in its policy stance. Overall, we think the BoJ's recent actions demonstrate that it is willing to innovate in its monetary policy measures and is committed to its price target. We think this continued policy divergence will continue to drive the JPY weaker against the USD.

Monetary Policy and FX Framework: After adopting a 2% inflation target in 2013, the BoJ has changed its main operating target for monetary market operations for a monetary base control, from the uncollateralised overnight call rate. Open market operations are conducted such that the monetary base increases at an annual pace of ¥80trn. In January 2016, the BoJ introduced a tiered interest rate regime, including a bottom tier of -0.1%. The Yen is formally a freely floating currency, but the MoF is in charge of FX policy and has often intervened in the past.

Growth/Inflation Outlook: GDP likely contracted in 2015Q4 and grew just 0.9% in 2015. We expect a small acceleration in 2016 to 0.8%. However, while the BoJ's new interest rate regime aims to stimulate capital expenditures, we have doubts this transmission channel will work. The fall in oil prices pushed inflation into negative territory for the first time since 2013. But weaker inflation is not just an oil story, as core of core is also likely to fall short of the BoJ's forecast. We believe the Bank of Japan needs to ease further to avoid losing inflation momentum.

Monetary Policy Forecast: The BoJ is currently purchasing ¥80trn-worth of JGBs annually up to a maturity of 40 years and an average duration of between 7 and 12 years, as well as other assets such as REITs. The BoJ has committed to expanding its balance sheet until the price stability target of 2% is reached sustainably. Following its interest rate actions in January, we expect the BoJ to be on hold for a time to assess the impact of its new easing measures. If the inflation outlook were to deteriorate, we believe the most likely response would be further interest rate cuts.

Fiscal Policy Outlook: The Japanese government announced its latest fiscal consolidation plan on June 30 and its medium/long-term outlook on July 22. We think it will be difficult to achieve these new targets given their optimistic growth assumptions. We expect government spending to grow 1.2% in 2015 and 0.8% in 2016.

Balance of Payments Situation: The Japanese current account has improved substantially over the last year, partly owing to the decline in oil prices. Nevertheless, the BBoP has declined as a result of higher portfolio outflows.

Things to Watch: On the one hand, we are watching for any signs that the economy is responding to ongoing monetary easing. On the other, we are watching for signs that the BoJ could start to waver on its inflation target.