Yen resumes weakening trend in run up to election

JPY: Quick reversal of yen strength ahead of Lower House election

The yen has continued to weaken this week ahead of the Lower House election on 8^th February. After hitting a low of 152.10 on 27^th January, USD/JPY has risen to a high of 156.47 overnight. The pair is moving back closer to levels prior to reports of rate checks by the New York Fed on 23^rd January when it was in the high 150.00’s. The quick reversal of yen gains at the end of January driven by heightened speculation over the potential for joint intervention between Japan and the US has been encouraged both by: i) the broad-based US dollar rebound triggered by President Trump’s nomination of former Fed governor Kevin Warsh to be the next Fed Chair, and ii) building confidence amongst market participants that Prime Minister Takaichi’s decision to call a snap election will prove successful in strengthening her grip on power in Japan. The Asahi Shimbun poll (click here) released at the weekend provided a strong indication that the ruling coalition government of the LDP and Japan Innovation Party are likely to build on their slim majority in the Lower House, and may even secure a two thirds majority although that would be a bigger surprise. It would provide Prime Minister Takaichi with a stronger mandate to continue implementing her “reflationist” policy agenda which encouraging renewed speculative selling of the yen even as there is a higher risk of direct intervention if USD/JPY moves back closer to the 160.00-level. A positive result for the government in this weekend’s election could put them in a more challenging position as the yen is likely to weaken at least initially putting more pressure on Japan to back up verbal intervention. The situation has potentially been made harder as well by last week’s comments from US Treasury secretary Scott Bessent who when asked whether  the US was stepping in responded “absolutely not”. At the same time, he reiterated that the US maintains a strong US dollar policy. The comments have helped to dampen expectations over the risk of joint intervention which had  powerful impact in strengthening the yen at the end of January.

The other main developments overnight have been reassuring comments from President Trump that have helped ease concerns over military conflict with Iran. He told reporters at the White House that “we are negotiating with them right now” and “they’d like to do something”. It followed earlier reports that a US warplane had shot down an Iranian drone in self-defence as it “aggressively approached” the USS Abraham Lincoln with “unclear intent”. White House Press Secretary Karoline Leavitt confirmed that US-Iran talks involving Trump’s Middle East envoy Steve Witkoff are still scheduled to take place on Friday. The price of Brent crude oil has risen back up towards USD68/barrel but remains below the high from last week at USD71.89/barrel reflecting more optimism that a diplomatic solution can be reached to avoid military action and potential supply disruption in the oil market. The Norwegian krone  has been one of the main beneficiaries in the FX market from the higher price of oil at the start of this year strengthening by almost 5% against the US dollar. On the other hand, the higher price of oil provides another headwind for the yen so long as it does not trigger a significant correction lower for risk assets and unwind for yen-funded carry trades.                                        

GBP BENEFITS FROM SCALING BACK OF BOE RATE CUT EXPECTATIONS

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Extending rebound ahead of BoE policy meeting

The pound has continued to strengthen at the start of this week ahead of tomorrow’s BoE policy meeting. EUR/GBP broke below support from the 200-day moving average at around 0.8650 on Monday. It is the first time that the pair has closed below the 2000-day moving average since April of last year as it moves further below the high of 0.8865 recorded on 14^th November prior to the release of the Autumn Statement. The stronger pound reflects both a reduction in UK fiscal and political risks after the Budget was released, and building evidence of a pick-up in growth momentum in the UK as uncertainty has faded. The latest PMI surveys for January revealed that business confidence jumped to its highest level since April 2024.

Stronger growth momentum has encouraged market participants to push back the timing of the next BoE rate cut. The UK rate market currently expects the BoE to leave rates on hold until the April or June MPC meetings. Without an immediate catalyst to lower rates further, the BoE are likely to remain cautious over lowering rates further at the start of this year. At the last policy meeting, the BoE stated the “Bank Rate is likely to continue on a gradual downward path. But judgements around further policy easing will become a closer call”.

We continue to expect the BoE to lower rates further this year but recently pushed back our forecast for the timing of the next BoE rate cut from March to April (click here). A development that is helping to provide more support for the pound in the near-term. However, the combination of labour market weakness and slowing inflation in the coming months should provide more encouragement for the BoE to resume rate cuts this year while the ECB leaves rates on hold. At the same time, UK political risks could increase around the local elections scheduled to be held in  May. As a result, we are not convinced that the pound’s current upward momentum against the euro will be sustained beyond Q1.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com