Japan’s core Consumer Price Index (CPI) rose by 2.7% year-on-year in August, down from 3.1% in July, but still above the Bank of Japan’s (BoJ) 2% target. When fresh food and fuel are excluded, the index showed a 3.3% increase, slightly lower than the previous month’s 3.4%. This information brings some comfort to households, yet it’s still strong enough for the BoJ to remain cautious. Policymakers are expected to keep interest rates at 0.5% after their meeting concludes on Friday. Governor Kazuo Ueda has stressed the need for patience due to uncertainties surrounding the impact of U.S. tariffs on Japan’s economy.

BoJ’s Short-Term Outlook

The BoJ expects that short-term price pressures from food and imports will lessen. Additionally, they predict that wage growth and consumer spending will gradually support more stable inflation. Reports suggest that the BoJ will likely keep the current rate during the September meeting, with MUFG indicating that any rate increase may be postponed until January 2026. Japan’s inflation data is scheduled for release on September 19, 2025, following the BoJ meeting. As Japan’s inflation decreases yet remains above the Bank of Japan’s target, the central bank’s decision to maintain rates at 0.5% is already expected. This could lead to a period of low volatility in the yen over the next few weeks. Such an environment is good for strategies that benefit from stable markets, like selling short-dated strangles on the USD/JPY pair.

Market Implications

The key factor for the currency is the large interest rate gap between Japan and the United States. With the U.S. Federal Reserve’s policy rate at 3.5%, the 300-basis-point difference still makes yen-funded carry trades very attractive. This fundamental situation is likely to keep the yen weak against the dollar. We are reminded of the period from 2022 to 2024 when a widening rate gap led to a sharp drop in the yen. Although the BoJ has moved away from negative rates, the main issue remains unchanged. The high cost of holding long yen positions is likely to deter any significant strengthening of the currency for now. For equity traders, the central bank’s cautious approach and the resulting weakness in the yen are positive for the Nikkei 225. A weaker yen enhances the overseas earnings of Japan’s major exporters, which may boost the index. We see opportunities in using Nikkei futures or call options to capitalize on this ongoing support. The main risk to this view is if wage growth, which averaged a 4.1% increase in recent negotiations, starts to drive domestic demand more vigorously than expected. If data shows that real wages are becoming positive, it could prompt the BoJ to adopt a more hawkish stance sooner than anticipated. We will closely monitor retail sales and services PMI data for any indications of this shift. Create your live VT Markets account and start trading now.

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