Inflation in Japan is rising. Normally that helps a currency. Not here. Yen kept falling Friday and hit another 40 year high against the dollar because the market does not care about Japan’s inflation data nearly as much as it cares about Japanese interest rates staying low.
Another 40 Year High for Dollar Against Yen
USD/JPY pushed to 163.90 Friday morning. Another 40 year high. Level keeps getting tested and keeps breaking higher because nothing fundamental has changed to stop it.
Japan released inflation data Friday. Core inflation which strips out fresh food prices came in at 1.6% in June. Matched forecasts and marked the first acceleration since March. Headline inflation at 1.7%. Core-core which removes both food and energy eased slightly to 1.7%.
Rising inflation normally supports a currency. When prices are climbing central banks are expected to raise rates. Higher rates make local assets more attractive. Capital flows in. Currency strengthens.
Japan is not following that script. Traders looked at 1.6% inflation and kept selling yen anyway. Reason is simple. Bank of Japan interest rates are still extremely low relative to everywhere else in the world especially the US. The rate differential overwhelms the inflation signal. Speculators borrow yen cheaply and deploy it elsewhere. That trade works as long as Japanese rates stay low and it has been working for a long time.
Oil Is Making Japan’s Situation Worse
Japan imports almost all of its energy. When oil is above $100 per barrel and the yen is at 40 year lows against the dollar every barrel costs significantly more in yen terms than it did a year ago. That combination is a direct hit to the Japanese economy.
Government subsidies have cushioned households from some of the pain. Businesses have not been as protected. Producer prices jumped 7.1% in June. Fastest pace since March 2023. Companies absorbing those input cost increases either compress margins or pass costs to consumers. Neither is comfortable.
Imported inflation driven by weak currency and high oil is a specific kind of problem for Japan. Cannot be solved by the kind of demand management tools central banks normally use. It requires either the yen to strengthen or oil to fall. Right now neither of those things is happening in a sustained way.
Bank of Japan Officials Are Getting Worried
Reports this week suggested some Bank of Japan officials are becoming increasingly concerned. Weak yen combined with rising fuel costs could keep inflation higher for longer than the central bank wants. That concern is reportedly opening internal discussion about faster rate hikes than markets currently expect.
That is a meaningful shift in tone. Bank of Japan has been one of the most reluctant central banks in the world to raise rates. Decades of fighting deflation made the institution deeply cautious about tightening. Moving faster than the market expects would be a significant policy shift.
Problem is even if BoJ raises rates faster the gap with the US is still enormous. Fed is at 3.5% to 3.75%. Even two or three surprise hikes from BoJ over the next year would not close that gap meaningfully. Market knows this and that is why every yen rally gets sold into. Structural disadvantage for the yen does not disappear with incremental tightening.
Intervention Keeps Getting Talked About
Japan spent more than $70 billion intervening in currency markets earlier this year. Knocked 500 pips off the pair at its most aggressive. Effect lasted a few weeks. Dollar came back and eventually made new highs.
Same pattern playing out again. Authorities make noise about decisive action. Market tests the highs anyway. Intervention slows things temporarily. Fundamental drivers reassert themselves.
Until Bank of Japan actually narrows the interest rate gap with the US in a meaningful way traders will keep treating yen rallies as selling opportunities. Every bounce gets faded. Every intervention gets eventually reversed by the underlying carry trade dynamics.
164 was the level Friday. 165 is what most strategists see as the next uncomfortable threshold where Tokyo might feel forced to act. Whether they do or just issue more verbal warnings is the question that keeps repeating itself every few weeks in this pair.