Josh O'Byrne, Currency Strategist at Citi, on Japan's economic outlook and Yen

After the surprisingly strong data in the first quarter, bolstered by rush demand and business investment, Citi economists expect Q2 growth to contract by 4.3% at a seasonally adjusted annual rate, and then rebound 2.9% in the third quarter of the year. Although, the sales tax induced distortions, Q3 is really the first quarter to get a good gauge on Japan's position. We are watching the degree to which more encouraging wage agreements amongst unionized workers spreads across smaller companies and developments in so called core-core inflation (excluding food and energy). Therefore, these could prove the first indications for whether the BoJ will need to ease further.

There are a few things we anticipate to exert downward pressure on the JPY going into the second half of 2014. 

Firstly, Citi economists expect the BoJ adding stimulus toward the end of the year, expanding the balance sheet further; although, somewhat delayed relative to the market expectations. Secondly, we anticipate the Government Pension Fund and other domestic investors beginning to position portfolios to better reflect the economies transition to higher inflation. Therefore, this could mean lower allocations to domestic bonds, more equities and foreign stocks. Hence, even small allocation shifts could have a marked impact given the substantial size of these holdings.

Finally, with the macro environment fairly benign at present, investor appetite for return could support further monetary stimulus. Despite the BoJ viewed as perhaps the G10 bank with the most dovish outlook, the JPY could remain the funding currency of choice.

In the second quarter of 2014 Citi expects USD/JPY to trade at 100; however, EUR/JPY to trade at 140. As for the end of 2014, Citi research sees USD/JPY returning to 105 and the EUR/JPY to 141.