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The US dollar continued its gains against the Japanese yen, exceeding the 159 yen level during Tuesday’s trading, at a time when investors found themselves facing a remarkable paradox: accelerating inflation within Japan and rising expectations of tightening monetary policy, versus the continued weakness of the Japanese currency and the strong momentum supporting the dollar.
The dollar/yen pair rose by about 0.3% to trade above the 159.00 level, after new data showed that inflationary pressures within the Japanese economy may be stronger than reflected by traditional market indicators.
The Bank of Japan’s latest core inflation gauge revealed that inflation rose to 2.8% in April, up from 2.5% in March, clearly exceeding the central bank’s 2% target. This indicator differs from typical core inflation data in that it excludes the effects of government support and temporary factors that can distort the true picture of price trends, making it a more accurate tool for measuring underlying inflationary pressures within the economy.
The difference is most evident when compared to the official core inflation index, which the Japanese government reported to have read at 1.4% last week, suggesting that actual inflation may be moving at much higher levels than the headline figures suggest.
This development comes at a time when the Bank of Japan is trying to reshape the markets’ understanding of the inflation trajectory, after it began publishing this new measure last March with the aim of providing a clearer picture of whether price pressures have become more sustainable or are still affected by temporary factors and government support programs.
In this context, Bank of Japan Deputy Governor Ryozo Himino reinforced the bank’s hawkish tone, emphasizing the importance of maintaining the credibility of monetary policy in the face of inflation and indicating that interest rates could rise further as long as economic and financial conditions continue to support a tighter monetary policy. Despite previous interest rate hikes, real interest rates in Japan remain relatively low after adjusting for inflation, which supports the prevailing market belief that the central bank may continue to raise rates gradually in the coming months.
But the economic landscape is not unaffected by geopolitical developments, as high energy prices linked to Middle East tensions add another layer of complexity for Japanese policymakers. Rising fuel costs are putting pressure on households and businesses, prompting the government to intervene again with new support schemes to ease the cost of living.
Prime Minister Sanae Takaichi’s government announced a supplementary budget that includes new measures to support fuel prices, a move aimed at protecting consumers from an energy shock, but which at the same time could make reading inflation more complicated due to the impact of government support on economic data.
Based on this data, market participants are pricing in an almost 80% probability of the Bank of Japan raising its short-term interest rate to 1% next month, compared to its current level of 0.75%. However, the yen continues to weaken against the dollar, indicating that the strength of the US currency and its supporting momentum are still outweighing expectations of monetary tightening in Japan.
