The Bank of Japan left its policy rate unchanged at 1.25% last week and described underlying inflation as "generally consistent" with its 2% price stability objective. UBS views that inflation assessment as an important milestone that bolsters the rationale for further policy normalization.
Despite that, UBS noted the BoJ opted not to press ahead with back-to-back rate hikes. The bank interprets this decision as an indication that the central bank has not shifted toward a markedly more aggressive tightening cycle.
UBS said the pause in rate increases diminishes the likelihood of another large bout of yen weakness. At the same time, the bank cautioned that the conditions needed for a sustained yen recovery have not been established.
According to UBS, three primary factors should continue to lend support to USD/JPY:
- Still-negative Japanese real interest rates.
- Elevated oil prices.
- Relatively high U.S. yields.
These elements, the bank argues, create an environment where the dollar's strength against the yen may persist unless and until domestic real rates in Japan turn positive or other supporting conditions change.
UBS framed the BoJ's inflation assessment as a key development that strengthens the case for gradual normalization of policy, even though the central bank chose to pause on immediate further increases. The pause, UBS said, reduces the near-term risk of an abrupt depreciation of the yen but falls short of the prerequisites needed for a durable currency recovery.
Market participants will likely weigh the interplay between Japanese real rates, commodity price dynamics and U.S. yield levels when assessing the outlook for USD/JPY in the coming period.
Note: The report reflects UBS’s interpretation of the BoJ’s policy stance and the balance of drivers affecting USD/JPY as described above.