The yen held just stronger than 118.0 against the dollar ahead of the Bank of Japan policy announcement and, after temporary losses to 118.25, the… … yen strengthened to 117.25 in Europe on Thursday.

Following its monetary meeting, the
central bank announced that it would end the quantative monetary policy after
five years and switch to a environment of interest rate targets. The bank has
also set a 0-2% reference target for the inflation rate. It will probably take
several months for excess liquidity to be withdrawn from the system which will
keep interest rates low and the bank has also pledged to keep interest rates
close to zero over the next few months.

The commitment to low interest rates
will reinforce the yen's lack of yield support and this will maintain the
temptation to sell the yen on yield grounds, but the policy shift will still
have important medium-term implications. A reduction in market liquidity will
gradually tighten liquidity conditions and should lessen the potential for
aggressive yen selling.

There will also still be capital
repatriation back to Japan on seasonal grounds before the end of March and there
will also be continuing pressure for a reduction in carry trades which will
maintain a flow of funds into the yen. In this environment, the yen should be
able to resist substantial losses, especially if there is are further stresses
in emerging markets, as there will be greater caution over pushing funds
overseas.

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