The Bank of Japan (BoJ) is set to raise interest rates to 0.75% this month, sending the USD/JPY pair lower as the Japanese yen (JPY) strengthens. Michael Pfister, foreign exchange market analyst at Commerzbank, notes that further BOJ increases and stronger-than-expected Fed cuts could narrow the interest rate gap between the US and Japan to 150 basis points by the end of 2026, supporting additional gains for the yen.
The yen gains as market prices rise for Japanese interest rates
“Another hike in Japanese interest rates is approaching. While the first signs that policymakers were considering such a move at the December meeting appeared in September, the signals have intensified since then. Reports emerged overnight that policymakers are prepared to raise interest rates, provided there are no unexpected shocks before the meeting in just under two weeks. The Bank of Japan’s intention to raise interest rates to 0.75% this month could not be clearer.
“If inflation remains above the central bank’s target for an extended period, policymakers risk losing their credibility. I also criticized the Bank of Japan’s 2024 rate hike because we simply have not seen the ‘second force’ identified by the Bank of Japan, namely sustained domestic inflationary pressure driven by services. However, the central bank cannot ignore volatile components indefinitely. In recent decades, hyperinflation has not been a problem in Japan, so market participants are likely to endure a long period of “Rising inflation but at some point, that will no longer be the case.”
“The fact that the market is now pricing in stronger Japanese rate hikes is finally benefiting the yen – after several weeks of higher levels, USD/JPY is finally heading lower again. Lower levels, i.e. a stronger yen, are likely to be on the cards. We expect another rate hike from the Bank of Japan in April (to 1%), and expect stronger rate cuts from the Fed than the market expects. Ultimately, the interest rate spread will likely fall to 150 basis points by the end of the year next year, with the yen correspondingly appreciating against the US dollar.”
