Aussie Dollar Steady, BOJ to Dominate Today's Proceedings

After a brief period below 105-figure after Monday's open, the Aussie dollar adhered to a tight 25 pip range overnight, with little in the way of major themes to encourage a break-out. With no major local event risk until Wednesday's CPI, we anticipate residual moves from today's BOJ policy decision to guide the way. 

We consider today's BOJ decision event risk of the highest order given the high expectations of stimulus built into Yen pairs. In effect, today's BOJ policy meeting has a propensity to shape the short-term fortunes of unrelated currency pairs by means of residual strength or weakness. Any significant moves from the AUDJPY will no doubt play a major role in where the AUDUSD heads today.

This week we will also find out just how much "scope" Stevens and Co at the Reserve Bank has to cut interest rates, with the greatly anticipated fourth-quarter inflation data on the docket. Consensus estimates show consumer prices will increase 0.4 percent in Q4 to represent annual inflation growth of 2.4 percent from 2-percent in the third quarter.

True to form, it will be the RBA's preferred measure of inflation (the trimmed mean and weighted median) that will be the market mover - both of which are expected to show 2.4 percent growth in annual terms, neatly between the Reserve Banks 2-3 percent target range. The currency implications are fairly simply with any on-target or below the expected reading suggesting the RBA have the ample scope to take the official cash rate below 3-percent, which in theory should encourage short-term downside for the Australian dollar. A deviation above estimates will therefore be a short-term bullish sign for the Aussie.

Yen consolidates ahead of BOJ

With U.S markets closed for Martin Luther King Jr. holiday, liquidity was suitably lighter than usual overnight and most currencies were confined to a narrow range.

Yen moves were slightly more pronounced, performing well against major counterparts ahead of today Bank of Japan policy decision. Nonetheless, it would appear the moderate strength seen resemble a period of natural consolidation ahead top-tier event risk, rather than a meaningful correction.

The USDJPY pair fell to lows 89.33 Yen overnight, before regaining ground over the course of the evening with supportive behavior at 89.7 noted in recent hours. Similarly we've seen gains against risk counterparts, led by gains against sterling, Kiwi and Euro.

European markets closed higher across the board with little in the way of economic data to counter the trend after a positive US lead on Friday. Investors also found solace in comments from Germany's Bundesbank, which highlighted Germany's stronger economic prospects going forward.

Europe's elite have also commenced a two-day meeting in Brussels and leaders around the globe will enjoy some time in the Swiss Alps this week for the annual World Economic Forum in Davos, which will no doubt provide some headlines for markets to mull over in the coming days.

'Abe trade' put to the test

Whatever way you look at it, today's BOJ policy decision certainly has that air of nervousness about it only weeks of built-up speculation can provide. The Yen's rapid decline since the Noda government dissolved parliament in mid November places today's BOJ decision in the top category of event risk. Since this time the Yen has declined a remarkable near 20-percent against the Euro, and around 13-percent against the greenback and significant weakness across all major counterparts.

First and foremost, markets will need to see the Bank - led by Governor Masaaki Shirakawa - adopt the government's recommendation of a 2-percent inflation target and display the sort of policy determination needed to achieve it. The level of selling aggression seen across Yen pairs in the last 2-month would suggest a simple incremental expansion of the bank's balance sheet would not suffice. Instead, to maintain the status quo, one would expect the bank would need to adopt new language to the effect of 'open-end' or 'unlimited' asset purchases until the new inflation target is in sight and/or the Yen has overshot a desired level. In addition, the BOJ may also consider reducing its official cash rate of 0.1 percent, essentially paying no interest on capital it holds for financial institutions - a move Governor Masaaki Shirakawa has previously opposed.

Koichi Hamada, advisor to Prime Minister Shinzo Abe, said yesterday if the Yen depreciates too much, easing initiatives should be stopped. So the question remains, how much is enough? From what we can glean from the barrage of feedback coming from a number of Government sources it would seem the 100 yen to the U.S dollar would be an appropriate target, while Hamada said yesterday the 110 yen to the dollar would be "too weak."

Japans Economy Minister Akira Amari last week warned of the potential negative repercussions of a fast falling currency. "If the yen excessively weakens, this would cause a spike in import prices," Amari said. "It would be a benefit for exports, but would have harmful effects on people's livelihoods." While he has since said his comments were taken out of context as they weren't referring to the current rate of exchange, the sentiment remains.