- GBP/JPY inches lower as traders expect the BoJ to deliver more rate hikes in the future.
- BoJ reiterated its commitment to further rate hikes if the outlook presented at the January meeting unfolds as expected.
- The Pound Sterling faces challenges due to the potential risk of stagflation in the UK economy.
GBP/JPY surrenders its recent gains from the previous session, trading around 193.30 during the European hours on Wednesday. The Japanese Yen (JPY) strengthened against its peers amid increasing expectations that the Bank of Japan (BoJ) will continue raising interest rates. Minutes of the December Bank of Japan meeting released this Wednesday showed that members emphasized the need for cautious monetary policy adjustments.
Meanwhile, investors are more confident that the BoJ will continue its move toward normalization and deliver additional interest rate hikes in 2025. Last week, the BoJ reaffirmed its commitment to further rate hikes and adjustments to its monetary policy stance if the outlook presented at the January meeting unfolds as expected.
Further downside risks of the GBP/JPY cross seem possible as the Pound Sterling (GBP) could face challenges due to the increased likelihood of the risk of stagflation in the UK economy, driven by weakening labor demand and persistent inflation.
Traders are currently pricing in a 25 basis point (bps) rate cut in the Bank of England’s (BoE) first monetary policy decision of 2025 on February 6, which would bring borrowing rates down to 4.5% amid the sluggish economic outlook.
On Tuesday, UK Prime Minister Keir Starmer gave optimistic remarks on the economy in a Bloomberg interview. Starmer emphasized that the Labour government’s top priority is "growth" and noted that the economy is beginning to "turn around." He also highlighted the strong trade ties between the United States (US) and the UK, stating that "we’ve got a huge amount of trade with the United States already, and the base is there for even better trading relations. We need to build on that."
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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