USD/JPY lifts as Japan’s GDP shrinks and USD stays supported on inflation fears

USD/JPY is moving higher on Friday as traders respond to weak growth figures from Japan and rising inflation expectations in the United States. 

At the time of writing, the pair is up 0.22% around 146.00, with focus now shifting to upcoming comments from US Federal Reserve (Fed) officials on Monday, which could offer clues on interest rate policy. 

Broader risk sentiment has turned cautiously positive, with equities stabilizing and Treasury yields holding firm, lending near-term support to the US Dollar (USD) against the Japanese Yen (JPY).

Japan’s GDP contraction highlights fragility in economic recovery, pressures BoJ policy path

The initial driver of the USD/JPY move was Japan’s weaker-than-expected Gross Domestic Product (GDP) report for the first quarter. The economy contracted by 0.2% QoQ, compared to forecasts of a 0.1% decline, and dropped 0.7% YoY. This was Japan’s first economic contraction in a year, raising concerns about the durability of its recovery. 

Consumer spending stalled, exports declined, and a sharp rise in imports widened the trade gap, adding to the country’s economic headwinds.

The data suggests Japan’s economy remains vulnerable and that the Bank of Japan (BoJ) may be forced to delay any further interest rate hikes. 

BoJ policymaker Toyoaki Nakamura added weight to that view on Friday, telling Reuters that “Japan’s economy is facing mounting downward pressure” and warning that moving too quickly on rates could hurt both consumer and business activity.

US consumer sentiment slumps but inflation fears surge, complicating Fed outlook

At the same time, markets were shaken by the latest preliminary University of Michigan consumer data from the United States. While sentiment fell sharply to 50.8, its second-lowest reading ever, short-term inflation expectations unexpectedly jumped. 

Consumers now expect prices to rise 7.3% over the next year, up from 6.5% in April, and the highest reading since 1981. This matters because it signals that households are bracing for continued cost-of-living pressures, which could force the Federal Reserve to keep interest rates elevated for longer, even if economic confidence is fading.

While the Yen often gains during global risk aversion, the weak GDP data undermines its longer-term strength. If Japan’s economic outlook deteriorates further and inflation recedes, markets may revert to selling the Yen, especially if the Fed maintains its policy stance.