Japanese consumer prices returned to positive territory in January. The core infl ation rate rose for the fi rst time in a year. The markets are expecting that Japan’s infl ation will pick up a level above 1% by the end of the year; however, this is still below the Bank of Japan’s 2% target. The Bank of Japan will likely keep rates in negative territory and continue its quantitative easing programme until it sees a sustainable pickup in infl ation. Whilst infl ation shows a positive sign, Japan’s overall household spending has remained below 0% since April 2016, showing that domestic demand remains weak. Japanese industrial production for January, month-over-month, fell to -0.8% the lowest level since May 2016.
US labour market data for February outperformed expectations, indicating that the US labour market condition has remained solid. US unemployment rate has seen a continuous decline since early 2011. The improvement in the unemployment rate has pushed the average earnings up since early 2015. In addition, seven out ten FOMC members, including the Fed doves Yellen and Brainard, have recently made hawkish comments.
We can expect that the Fed will announce two to three rate hikes this year. If the Fed does not adhere to raising rates they are highly likely to face a credibility issue. In theory; the divergence between the two central banks’ monetary policies will likely result in USD strengthening against JPY with the USD/JPY bull trend likely to continue.
US President Trump’s prospective “protectionism policies” and his weak-dollar stance might pose downside risk to USD which will result in JPY strengthening against USD. With that said we may see Japanese companies holding back from pay rises, which would undermine domestic demand and further economic development. Moreover, markets have largely priced in the expectations for prospective rate hikes in 2017 since the end of 2016.
Taking into consideration all these relevant factors then USD is likely to keep on fi rming against JPY at a comparatively modest pace over the following months until Trump’s next proposal of protectionism on trade and a weak dollar policy.