The Bank of Japan faces a dilemma: as the path of inflation fluctuates, interest rate hikes will weaken the economy

FX678 Finance ·  May 24 17:50

During the European session on Friday (May 24), USD/JPY operated within a narrow range, hitting a low of 156.873. The intraday report was 156.988, up 0.07%.

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Japan's CPI declined somewhat in April as record wage increases were not reflected in prices

Compared to April last year, Japan's overall inflation rate fell to 2.5% from 2.7% in March. Furthermore, the core indicator (excluding fresh food) fell from 2.6% to 2.2%, in line with expectations. Excluding highly volatile items such as fresh food and energy, the index fell from 2.9% to 2.4% because the lack of consumer activity seemed to be affecting the “healthy relationship” between wages and prices in Japan.

Since the Bank of Japan first raised interest rates in 2007, the Bank of Japan (BoJ) has conveyed a prerequisite for interest rate changes that depend on the board's confidence that inflation will stabilize and remain above 2%, which usually indicates a healthy relationship between wages and prices. The Bank of Japan also specifically stated that it is necessary to observe demand-driven inflation rather than “cost-driven inflation” brought about by a sharp rise in oil prices due to supply disruptions.

Since then, due to rising prices, the annual wage growth rate in Japan has reached the highest annual growth rate in the past 33 years, but inflation has not continued to rise. In contrast, inflation data has been inconsistent, and rising labor costs have yet to translate into higher consumer prices, which should have boosted inflation over time.

The Bank of Japan's challenge: weakening amid uncertain inflation path

Following a flat rate (0%) in the fourth quarter of last year, Japan's GDP fell 0.5% in the first quarter, narrowly avoiding a technical recession. A major concern observed from the weak data is local consumer spending and general consumption.

People rely on economic activity to stimulate economic growth and pave the way for another rate hike, but if consumers retreat, it will be very difficult to tighten the financial environment.Therefore, it may take some time before the Bank of Japan gains the necessary confidence to raise interest rates again. The market expects that it may raise interest rates by 10 basis points in July and 25 basis points throughout the year.

Meanwhile, sellers of Japanese government bonds (JGBs) seem to be declining, causing the 10-year Treasury yield to recently surpass 1%. The rise in yield indicates that the market has accepted that interest rates and yields are on an upward trajectory, and the Bank of Japan may reduce future bond purchases. Despite this, higher yields hardly boosted the yen, as US Treasury yields are also rising, and recent minutes from senior Federal Reserve officials and hawkish FOMC meetings have re-introduced the “long-term rise.”

The dollar rose again against the yen, but the trend was still suppressed

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(USD/JPY daily chart source: Easy Exchange)

Less than a month after suspecting Japanese officials interfering in the foreign exchange market, the dollar is now closer to the 160 mark against the yen. This level prompted Japanese officials to intervene in the foreign exchange market. However, the rise was gradual and did not show the kind of volatility that prompted officials to act.

In a quiet week with top US data, people generally expect the US dollar to strengthen, which caters to the market's preference for high-yield currencies during the period of low volatility observed.

After a sharp 50-day rebound, the pair traded above the Simple Moving Average (SMA) at 157.00 to return to the beginning of May, then rose above 155.00. As long as interest spreads between the two countries remain large, this problem is likely to continue. Arbitrage trading is still strong.

At 17:48 Beijing time, USD/JPY was reported at 156.999/157.010, up 0.07%.

The translation is provided by third-party software.

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