The Yen strengthens as markets price-in Bank of Japan hike

The Bank of Japan is expected to hike interest rates by 25 basis points when the central bank meets on Friday the 24th of January, 2025. Recent data flow and commentary by authorities have led the markets towards a hike, with swaps markets, at the time of writing, pinning the probabilities down to a 92% chance.

_{(Source: Bloomberg)}

The Bank of Japan has long been trying to engineer a “virtuous cycle” of rising incomes and prices, with the central bank seemingly achieving its goal. Wage growth is solid thanks to a tight labour market and institutional changes to wage setting, while inflation on a core basis is above the BOJ’s target and apparently accelerating.

_{(Source: Trading Economics)}

Given these upward pressures on prices, as can be seen above, the markets expect further interest rate hikes from the BOJ going forward. There is the potential for an upward revision in growth and CPI forecasts from the central bank in its updates Outlook for Economic Activity, a move which could consolidate pricing for another rate hike before the end of 2025.

_{(Source: Bloomberg)}

The Bank of Japan has been and will be cautious about how it guides the markets, after the volatility it heavily contributed to in August, 2024. The central bank’s larger than expected 25 basis point hike sent the Yen surging and Nikkei into free fall, leading to a rapid unwind of Yen carry trades. The BOJ has been slower to hike another time as a result of this experience, with the central bank carefully telegraphing the size of the likely move.

Because of the high probability of a hike from the Bank of Japan, absent a surprise holding steady of rates, market volatility will stem from changes in guidance. The strength in the data lends itself to a hawkish surprise, leading the markets to bring forward the timing of the next hike. Such a move would support the Yen and weigh on the Nikkei.

Yen looks poised for further strength as Nikkei remains rangebound

The Yen has climbed as the markets have priced-in a rate hike from the Bank of Japan, with the move compounded by a slight softening in the US Dollar as US President Donald Trump refrained from applying aggressive tariffs on trading partners upon returning to office. Having failed to make a new higher-high, momentum appears to be turning to the downside for the USD/JPY, with a break of an upward sloping trend potentially signalling a bigger drop into the 150s.

(Source: Trading View)
(Past performance is not a reliable indicator of future results)

Meanwhile, the Nikkei is largely range bound, failing to rise despite a weaker Yen and strong economic backdrop in Japan, largely due to a re-rating in global bond markets putting upward pressure on yields and downward pressure on stock valuations. A break of upward sloping support would be a bearish signal for the Nikkei; a break of the top of the recent range around 40,300 indicates a renewed uptrend.

(Source: Trading View)
(Past performance is not a reliable indicator of future results)