Japanese Yen weakens as surprise current account deficit weighs

USD/JPY advances 0.73% on Monday and trades around 158.95 at the time of writing. The Japanese Yen (JPY) underperforms against the US Dollar (USD), pressured by Japan’s unexpected current account deficit, although expectations of further interest rate hikes from the Bank of Japan (BoJ) could limit the currency’s weakness.

Data released on Monday by Japan’s Ministry of Finance (MoF) showed that the Current Account posted a deficit of ¥92.3B in June, while markets had expected a surplus of ¥1,512B.

The Ministry attributed the deterioration partly to higher Oil prices and significant dividend payments to foreign investors. The June shortfall, the first deficit recorded in 17 months, is therefore adding to selling pressure on the Japanese Yen at the start of the week.

Japan’s fiscal situation is also acting as a headwind for the currency. Public debt exceeds 200% of Gross Domestic Product (GDP), while Prime Minister Sanae Takaichi’s expansionary policies and proposed tax cuts are fueling concerns over long-term debt sustainability.

These concerns are helping to limit the lasting impact of interventions aimed at supporting the Japanese Yen. Japan intervened on three occasions between late April and early May before returning to the market with two additional operations in late July, including a coordinated intervention with the United States (US).

Japanese monetary policy, however, provides some counterweight to these pressures. The Summary of Opinions from the Bank of Japan’s (BoJ) July meeting showed that most policymakers retain a tightening bias. One member even argued that policy normalization may need to proceed faster than markets currently expect amid upside risks to prices.

On the US side, investors have nevertheless scaled back expectations of restrictive monetary policy from the Federal Reserve (Fed) following Friday’s weak employment data. This shift could limit the USD/JPY advance despite the Japanese Yen’s current weakness.

Attention now turns to the US Consumer Price Index (CPI) data for July, due on Wednesday. The inflation figures should provide fresh clues about the Fed’s interest rate path and could determine whether USD/JPY can extend its rebound above 159.00.

Japan rate debate shifts as BoJ weighs inflation overshoot risks

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 add that markets are now “pricing in roughly a 50% chance of a 25bp BoJ hike in September and a full hike by year-end,” underscoring a gradual but clear repricing of the policy path.

According to BNY, the latest BoJ discussions show that “several members argued that the bank should keep the policy rate unchanged at this meeting to assess the lagged impact of the previous hike, but 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.’”