July 31, 2018 / 10:49 AM / 2 months ago

FOREX-Yen set for biggest drop in nearly 3 weeks as BOJ signals policy intent

* Derivative markets signal cautious outlook for yen bears

* Swedish krona lead currency gainers in July, yuan losers

* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh

By Saikat Chatterjee

LONDON, July 31 (Reuters) - The Japanese yen fell against the dollar and is poised to register its biggest daily loss in nearly three weeks on Tuesday after the central bank pledged to keep interest rates low and adopted a forward guidance model to strengthen its commitment for its massive policy stimulus.

The Bank of Japan’s decision to keep settings at record low levels reassured market participants who were wary the Bank of Japan would signal an end to years of policy stimulus and encouraged investors to snap up relatively higher-yielding currencies such as the Australian dollar.

Some market watchers said Japan’s reluctance to change its policy aggressively stems from its desire to keep its currency competitive, especially against the Chinese yuan, after Beijing let its currency weaken by more than 7 percent versus the dollar since mid-June as trade war tensions escalated.

The Japanese yen weakened 0.4 percent to the day’s low against the dollar at 111.595 and about 0.8 percent above an intraday low of 110.75 hit in Asian trade.

Against the euro and sterling, the yen weakened 0.6 percent each.

“China’s push to keep its currency weak is also a big factor in Japan’s decision today and that is driving the yen’s weakness against its rivals,” said Simon Derrick, chief currency strategist at BNY Mellon In London.

The BOJ pledged to maintain its short-term interest rate target at minus 0.1 percent and decided to guide 10-year JGB yields around zero percent.

BILLIONS

Ahead of the BOJ decision, markets had speculated Tokyo may be preparing to roll back its massive stimulus policies prompting some speculators to cut back on their large short yen positions.

But the latest decision by the bank where policymakers also said the BOJ would allow long-term rates to fluctuate depending on economic and price developments, and conduct its bond purchases more flexibly, should encourage more bets.

“What the Bank of Japan has done today has signaled a cap on global bond yields and indicated the appetite for risk may have some more room to run,” said Viraj Patel, an FX strategist at ING in London.

German and French government bond yields dropped 3 to 4 basis points after the Bank of Japan move and the euro hopped a fifth of a percent higher at $1.17230.

Despite the yen’s weakness, derivative markets painted a slightly more cautious picture.

Some large option expiries around the 112 dollar/yen line amounting to nearly $1.5 billion over the next week should check further dollar gains against the euro while implied gauges of yen volatility ticked lower.

Inflation and GDP data out of Europe for the second quarter was broadly in line with expectations and failed to move the euro.

Besides the BOJ, meetings of the Federal Reserve and the Bank of England are in focus this week.

The U.S. central bank is expected to reaffirm the outlook for further gradual rate rises at the end of its two-day rate review through Wednesday while the Bank of England is expected to raise rates on Thursday for only the second time since the 2008 financial crisis.

Reporting by Saikat Chatterjee; Editing by Richard Balmforth

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