Japan will publish several key economic reports next week, after GDP recovery in the fourth quarter came in weaker than expected. January industrial production and retail sales are expected to rise.
Tokyo CPI inflation is likely to cool again as energy, utility, and food costs ease. Core inflation (excluding fresh food) is forecast to drop below 2%.
Near Term Data And Policy Expectations
If core inflation falls below 2%, the Bank of Japan is expected to keep its policy rate unchanged at 0.75% at the March meeting. The report adds that fiscal spending and winter bonuses may be supporting activity in January.
In early 2025, many expected a rebound in Japan’s activity alongside easing inflation. That mix would have let the Bank of Japan stay on hold. The thinking was that core inflation would move below 2% and keep the policy rate at 0.75% through the March 2025 meeting. This view implied low volatility and steady, predictable policy.
But inflation stayed much more stubborn through 2025 than expected. While Tokyo core CPI briefly dipped, it later picked up again. As of January 2026, it is running at 2.8% year over year, driven by wage pressure and a weaker yen. With inflation staying above the 2% target, the policy picture has changed.
As a result, the Bank of Japan dropped its “wait and see” approach later in 2025 and raised the policy rate to 1.00%, surprising markets that expected a longer pause. Current pricing suggests at least two more rate hikes could happen before year-end. The period of a passive central bank seen last year now looks over.
Implications For Yen And Rates Volatility
A major factor is the yen. It has weakened further against the dollar to around 162, a multi-decade low not seen since the late 1990s. This lifts import costs and creates a tough feedback loop for the central bank. Ongoing yen weakness adds to inflation pressure and increases the case for higher interest rates.
For derivative traders, this makes “low-volatility” trades in Japanese rates more risky. Instead, trades that benefit from larger swings in Japanese government bond (JGB) futures may make more sense. Markets may be underestimating how forcefully the Bank of Japan could respond.
In FX, this backdrop also puts the focus on yen derivatives. With the yen so weak, options that profit from a sharp rebound—such as buying low-cost, out-of-the-money JPY calls—may offer attractive risk-reward. If the Bank of Japan turns more hawkish than expected in the coming weeks, the yen could rally quickly.
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