USD/JPY: Weakening upstream inflation bodes ill for BOJ wage acceleration

• Wholesale inflationary pressures are falling rapidly in Japan
• The BOJ wants to use higher consumer price inflation to encourage faster wage growth
• USD/JPY is back at range highs yet there’s been no attempt from the Japanese government to talk it lower

Japanese wholesale inflationary pressures are slipping away rapidly even with a significantly weaker JPY, boding ill for the Bank of Japan’s (BOJ) attempts to use a rebound in consumer price inflation (CPI) to generate second-round effects through greater wage pressures.

Japan upstream inflationary pressures coming off hard

The Japanese government released updated corporate goods price inflation data for October on Monday, revealing a substantial undershoot on what was expected by markets. The report, akin to producer price inflation reports from other advanced economies, slumped 0.4% during the month, seeing the annual rate increase decelerate rapidly to 0.8%, well below the 2.2% pace of September. Economists had expected prices to hold steady in October.

While wholesale costs are worn by businesses, not consumers, as a major manufacturing nation reliant upon demand trends from abroad, any global economic slowdown next year could easily see weaker upstream price pressures filter through to the consumer level just as key wage negotiations in Japan are scheduled to begin.

Weakening inflation pulse bad news for second round wage effects

For a nation battling a deflationary mindset dating back decades, this is not an ideal scenario for the BOJ who are continuing to move towards normalising monetary policy just as other central banks are on a path towards doing the exact opposite.

For USD/JPY, weakening inflationary forces in Japan will likely mean interest rate differentials with the rest of the developed world will remain higher than what would otherwise be the case, keeping the Japanese yen under pressure. In the near-term, in the absence of a significant shift in the outlook for US interest rate outlook, it suggests the bias for USD/JPY remains to the upside. And that means the possibility for fresh multi-decade highs for the pair and greater risk of FX intervention from the BOJ on behalf of the Japanese government.

USD/JPY nears fresh highs with verbal intervention absent

USD/JPY is trading within touching distance of the high of 151.72 set in September after the BOJ failed to live up to hawkish expectations regarding the winding back of its yield curve control program. Even though Japan will release preliminary Q3 GDP data on Wednesday, that report is unlikely to move the dial for the pair this week. Instead, with many Federal Reserve speakers and consumer price inflation data out on Tuesday, whether USD/JPY breaks to fresh highs will likely be driven by the USD side of the equation unless the BOJ is instructed to intervene.

Curiously, despite where the yen is trading, there has been no verbal intervention attempts from either the BOJ or Japanese government so far on Monday. That may embolden traders to push for fresh highs.

151.72 is the first upside level to watch with 151.95 – where the BOJ conducted a market check in 2022 that sent USD/JPY tumbling hundreds of pips within seconds – the ultimate prize for bulls. Beyond there, 160 and 180 will be openly discussed. On the downside, channel support is found above 150, making that the first meaningful level of note. 148.40 and 147.50 are located further below.

-- Written by David Scutt

Follow David on Twitter @scutty