The Bank of Japan said its new gauge of underlying inflation, which excludes one-off and institutional factors such as education and energy-related subsidies, rose to 2.8% in April, up from 2.5% in March and above its 2% target. By contrast, the “core-core” CPI measure excluding special factors increased 2.2% in April after a 2.6% rise in March, while the government’s benchmark core CPI print stood at 1.4% year on year, well below the BoJ’s preferred measure.
In markets, USD/JPY was 0.05% higher at 159.01 at the time of writing. The BoJ, Japan’s central bank with a price-stability objective of around 2% inflation, has operated an ultra-loose stance since 2013 through Quantitative and Qualitative Easing, later adding negative rates and yield control over 10-year government bonds in 2016, before lifting interest rates in March 2024. The yen weakened as policy divergence with other central banks widened in 2022 and 2023, then partly reversed in 2024 following the shift away from ultra-loose policy.
Implications For the Bank of Japan and Upcoming Policy Decisions
We see the new inflation data, showing a 2.8% core rate, as a clear signal that underlying price pressures are much stronger than official figures suggest. This puts significant pressure on the Bank of Japan to consider another interest rate hike to support the yen and manage inflation. Consequently, we are closely watching the upcoming policy meeting on June 14th for any shift in tone or action.
Market Reactions and Trading Strategies Amid Policy Divergence
Given the yen is trading near 159 to the dollar, the risk of a hawkish surprise from the BoJ or direct intervention from the Ministry of Finance is growing. We anticipate implied volatility on USD/JPY options will increase in the coming weeks as traders price in a wider range of outcomes. Buying yen call options or USD/JPY put options could be a prudent way to hedge against, or speculate on, a sudden strengthening of the yen.
The policy divergence with the United States remains stark, as the Federal Reserve’s key interest rate is currently holding firm at 3.75%. This wide interest rate gap continues to encourage carry trades, where investors borrow yen to buy higher-yielding dollar assets. This trade is likely to persist until the Bank of Japan signals more aggressive action, keeping underlying pressure on the yen.
We remember the BoJ’s first rate hike in over a decade back in March 2024 was a major policy shift away from its ultra-loose stance. This new inflation report, which purposely excludes temporary government subsidies, provides the central bank with the justification it may need for a follow-up hike. Therefore, positioning for a more hawkish BoJ is becoming a more central part of our trading thesis for the next several weeks.
