Yen Slides, But Rate Hike Dreams Still Alive, Say Analysts

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The Japanese Yen is at its lowest level against the Pound since April 03.

Yen weakness follows signals from the Bank of Japan on Thursday that it would be increasingly cautious about raising interest rates further, although analysts we follow say it's too soon to bet on such an outcome.

"The yen has weakened overnight following the BoJ’s latest policy meeting," says Lee Hardman, Senior Currency Analyst at MUFG Bank Ltd. "It follows the BoJ’s decision to leave the policy rate unchanged at 0.50% while the updated economic projections and risk assessment signalled more caution over delivering further rate hikes."

MUFG's currency strategists think the developments are reason enough to for traders to pare their 'long' positions on the currency. A 'long' is a bet that a currency would rise, something many market participants have anticipated now that the Bank is back in the habit of raising interest rates.

However, expectations for further hikes were curtailed after the Bank softened inflation forecasts and said that inflation risks are tilted down.

"The policy statement is extremely short and there is no mention that the BoJ still expects to hike rates further down the road. That is perhaps also why USD/JPY traded quite a bit higher," says Wilhelm Dalsjö, an analyst at Danske Bank.

Central banks raise interest rates in order to curb inflationary conditions, something Japan has started to contend with again following decades of relentless deflationary pressures.

However, structural shifts in the global economy and domestic reforms have rejuvenated inflationary forces again, allowing the Bank to raise interest rates.

Further hikes would be supportive of Japanese bond yields and the Yen, while any finality to the process would have the opposite effect.

"Domestic conditions support further increases in the BoJ’s interest rate, so long as the authorities negotiate a reasonable trade deal with the US," says Samara Hammoud, FX Strategist at Commonwealth Bank. "We expect the growth in sample‑adjusted core earnings – the BoJ’s preferred measure of wages – to accelerate."

The analyst says stronger wage growth will flow through to stronger core inflation and consumption

The Bank cut the outlook for Japanese growth by 0.6pp for 2025 and 0.3pp for 2026, blaming the trade war. Inflation forecasts have been cut by 0.2pp to 2.2% for 2025 and 0.3pp for 2026 to 1.7%. The new FY2027 forecast is 1.9%.

"With solid wage growth this year, reflating the economy is on track and thus we still believe the BoJ is ready to hike rates further. We expect the next hike in the fall with the timing of course largely depending on the outcome of the trade war," says Danske.

Danske Bank's forecasts USD/JPY to gradually trend lower toward 130 over the next 12 months.

MUFG says a slower pace of rate hikes will help to dampen yen strength in the near-term, "but is unlikely to reverse the current strengthening tren."

Even if the Bank of Japan holds tight going forward, it's apparent that other global central banks are likely to cut interest rates further, thereby lowering the difference in their interest rates with those of Japan.

For currencies, it is this differential that really counts, and a shrinking differential is, on paper, supportive of JPY.

"If global growth continues to slow and other major central banks including the Fed cut rates further resulting in yields spreads continuing to narrow between Japan and overseas," says Hardman.