The Strategist

BoJ resumes rate hikes: yen set to strengthen as yield gap narrows

The Bank of Japan (BoJ) recently raised its policy rate for the first time since last summer, resuming a gradual withdrawal of its long-standing monetary stimulus. Although the announcement was accompanied by relatively dovish guidance, we interpret the central bank’s stance as leaning more hawkish than it appears.

Date
Author
Sebastian Petric, LGT Senior FX Strategist, Georg Ruzicka, Head Equity Research LGT Private Banking
Reading time
10 minutes

Bank of Japan Head Office Building
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With inflation running above the 2% target and wage growth showing signs of sustained improvement, additional rate hikes are expected later this year, a scenario that could continue to support the yen. At the same time, the yen’s record-low valuation and Japan’s stable current account surplus are providing further fundamental backing. These factors, along with a narrowing yield differential between Japan and the United States, have led us to recommend selling USD/JPY in anticipation of a stronger yen.

A return to tightening

At its latest policy meeting, the BoJ opted to raise its policy rate by 25 basis points to 0.50%, a level not seen since 2007-2008. Although the central bank governor delivered dovish-sounding remarks to prevent an overly sharp yen appreciation, subtle shifts in the commentary reinforced the view that this hike may be the first of several in 2025. Many analysts anticipate at least two more hikes this year, possibly in the spring and summer, which would bring the policy rate toward 1.0%.

Several developments underpin this more hawkish outlook. First, wage growth continues to exceed many forecasters’ expectations, particularly in industries facing chronic labour shortages. This has bolstered household income and, by extension, consumer spending. Second, inflation in Japan, especially in the services sector, is stabilising around or above the BoJ’s 2% goal. Coupled with a rolling back of certain government subsidies, these price pressures make it easier for the BOJ to justify further tightening.

At the same time, when geopolitical or trade risks flare up, the market often seeks refuge in currencies like the yen. Recent headlines about possible tariffs in other regions appear to have sparked mild risk-off sentiment, prompting the yen to stand out going forward. 

Fundamentals in favour of the Japanese yen

Moreover, fundamental drivers are increasingly shifting in favour of the yen. FX valuation metrics suggest the USD/JPY exchange rate has traded at the upper bound of our expected ranges, while Japan’s consistent current account surplus underscores a robust external position. Crucially, key rate spreads, particularly between the United States and Japan, have started to narrow. With the BoJ now on a path to gradually normalise rates, the yen is losing some of its status as an ultra-cheap funding currency, which in turn could spark more positive sentiment towards the JPY.

For these reasons, there is a growing inclination to take short positions in USD/JPY. The pair has recently broken through the upper boundary of our expectations, yet some factors have swung back in favour of the yen. As rate hikes in Japan continue and US yields potentially remain steady or even drift lower in response to moderating growth prospects, the yield differential that has long favoured the dollar is diminishing.

A stronger yen poses a risk to earnings forecasts

The long-lasting devaluation of the yen helped the Japanese export industry gain global competitiveness. With the western world now embracing a new interest rate cutting cycle - although at different paces - Japan’s growth and monetary policy mix starts to turn less attractive at the margin. We believe the growth vs. monetary policy mix in Japan is past its "goldilocks" period. A potentially stronger yen may conversely give back some of that global competitiveness and sooner or later cause rising negative translation risks which would likely weigh on earnings forecasts. The above explained solid wage growth dynamics may further exacerbate near-term margin pressure of corporate Japan. Hence, we currently view Japanese equities as "Unattractive".

Conclusion

The BoJ’s decision to raise interest rates marks a pivotal point in Japan’s monetary policy. While the central bank has tried to temper market expectations with cautious wording, the outlook strongly suggests additional hikes this year. Against this backdrop, the yen appears poised for strength, supported by fundamentals such as a positive current account surplus, a narrowing yield differential with the United States, and its enduring appeal as a safe haven.

As a result, we see opportunities to sell USD/JPY. The break above earlier trading ranges may have been short-lived, with factors now converging to bolster the yen’s value. Should Japan’s wage growth and inflation data stay firm, and any escalation in global trade or geopolitical risks persist, the yen may appreciate, potentially bringing USD/JPY well below prevailing levels in the months ahead. Should this scenario materialise, we would expect it to translate in negative earnings revisions and potentially higher margin pressure for corporate Japan. We confirm our "Unattractive" rating for Japanese equities for the time being.

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