Australian Dollar jumps as Yen struggles with Japan’s fiscal woes

AUD/JPY rises 0.70% on Monday and trades around 112.25 at the time of writing. The pair benefits from broad weakness in the Japanese Yen (JPY), while the Australian Dollar (AUD) holds firm ahead of the Reserve Bank of Australia (RBA) monetary policy decision on Tuesday.

The Japanese Yen faces renewed selling pressure after Japan’s current account unexpectedly swung into a ¥92.3B deficit in June, compared with expectations for a ¥1,512B surplus. Japan’s Ministry of Finance (MoF) attributed the increase in outflows partly to higher Oil prices and significant dividend payments to foreign investors.

Japan’s fiscal outlook also weighs on the currency. With public debt exceeding 200% of Gross Domestic Product (GDP), Prime Minister Sanae Takaichi’s expansionary policies and proposed tax cuts are fueling concerns about long-term debt sustainability. These structural headwinds have limited the lasting impact of recent interventions aimed at supporting the JPY.

Meanwhile, the Bank of Japan (BoJ) maintains a tightening bias. The Summary of Opinions from its July meeting showed that most officials support further policy normalization, although Japanese interest rates remain relatively low compared with other major economies.

On the Australian side, attention turns to Tuesday’s RBA decision. The central bank is widely expected to keep its benchmark interest rate unchanged at 4.35% after raising rates three times so far this year. Investors will focus on the policy statement, updated forecasts and comments from RBA Governor Michele Bullock for clues about the likelihood of further tightening.

The Australian Dollar faces some pressure from China after annual consumer inflation slowed to a six-month low in July and producer price inflation eased more sharply than expected. Still, persistent Japanese Yen weakness remains the main driver behind AUD/JPY’s advance on Monday.

Analysts at Rabobank note that the Reserve Bank of Australia will set policy on Tuesday and observe that, while they are “not entirely convinced that the three hikes delivered since the start of the year are enough to mop up excess demand in the Australian economy,” the RBA “seems to hope it is.” As a result, they write, “we expect policymakers to hold rates unchanged this week, as do all other 31 economists surveyed by Bloomberg,” leaving Australian Dollar markets to take their cue from upcoming data. More broadly, Rabobank highlights that “it’s peak summer, with a light data calendar and most central bankers on holiday,” pointing out that “the Fed’s Hammack is an exception.”

Analysts at BNY note that “long-end JGB pressure is building,” with “inflation risks and fiscal concerns” pushing long-dated yields “toward the upper end of recent ranges.” They highlight that markets are now “pricing in roughly a 50% chance of a 25bp BoJ hike in September and a full hike by year-end,” reflecting a growing conviction that policy tightening will resume. According to BNY, the latest BoJ discussions show that while “several members argued that the bank should keep the policy rate unchanged at this meeting to assess the lagged impact of the previous hike, the overall tone favors further tightening.” In their view, “the debate has shifted away from lifting inflation to 2% and onto preventing an overshoot,” with some members warning that “waiting too long could force faster, larger rate hikes later, risking a ‘double shock.’”