Yen strengthens ahead of BoJ policy meeting

JPY: Tankan survey & wage report reinforce expectations for BoJ hike  

The yen has strengthened overnight ahead of this week’s BoJ policy meeting on Friday. USD/JPY has fallen back towards support at the 155.00-level. The yen has been lifted by the release of the latest Tankan survey which keeps the BoJ on track to resume rate hikes this week. The survey revealed that business sentiment in Japan remained resilient in the face of trade disruption. Business confidence among large manufacturers rose by +1 point to 15 in Q4 while confidence for large non-manufacturing firms held steady at 34. The survey also revealed that large firms across all industries plan to increase capital expenditure on average by 12.6% in the current fiscal year highlighting that recent policy uncertainty in Japan has not significantly discouraged firms from stepping up spending plans. With regards to inflation, businesses see inflation at 2.4% in five years’ time running well-above the BoJ’s 2.0% inflation target encouraged by further evidence of tightening labour market conditions. The diffusion index for input prices for large manufacturers rose by +2 points to 40 in Q4, and output price index rose by +1 to 25 indicating inflation pressures continue to build heading into year end.

At the same time, the BoJ released a special branch report overnight on companies’ wage setting behaviour in Japan. The report revealed that 29 of the central bank’s offices expect companies to raise salaries at about the same rate in fiscal year 2026 as in the current fiscal year. On the other hand, two branches expect higher wages and two see lower wage growth. The report noted that “it seems that the number of firms expecting a clear improvement in their profits is not large, partly owing to the effect of US tariff hikes”. Still, most firms “seem to consider that it is necessary to raise as much wages in fiscal 2026 as in fiscal 2025 or to a similar extent as the prevailing wage formed by other firms, with a view to retaining staff and improving their motivation amid persistent, severe labour shortages”. 

Overall, the latest Tankan survey and special branch report on wage growth should give the BoJ confidence that  Japan’s economy will continue to evolve in line with their outlook supporting the case to resume rate hikes this week. A 25bps hike from the BoJ is almost fully priced in now. Whether the yen continues to strengthen heading into year-end is likely to depend more on the updated guidance form the BoJ alongside a rate hike and external conditions. A deeper sell-off for US AI/tech stocks could provide support for the yen by disrupting favourable conditions for yen-funded carry trades. We expect the BoJ to indicate that further gradual rate hikes remain likely if their outlook for the economy is realized, and expect two further 25bps hikes in 2026. However if the next hike is not delivered until around the middle of next year, the BoJ’s policy update may fail to trigger a sustained reversal of the yen’s recent weakening trend while fiscal concerns in Japan remain a heavy weight. Please see our latest FX Weekly for more details (click here). Ahead of the BoJ’s policy meeting this week, Bloomberg has reported that the BoJ is likely to start the process of winding down their holdings of ETFs as early as next month. The market value of ETF holdings totals around JPY83 trillion, but the pace of unwind will be very gradual totalling JPY330 billion per year based on book value helping to limit market disruption.   

CHINA ALLOWING CNY TO STRENGTHEN MORE VS. USD

Source: Bloomberg, Macrobond & MUFG GMR

CNY: Soft domestic demand fails to dampen CNY’s upward momentum

The main economic data releases overnight were from China revealing a loss of growth momentum heading into year-end. The latest monthly activity revealed much weaker than expected retail sales growth. The annual rate of growth slowed sharply to 1.3% in November down from 2.9% in October. It was the weakest reading since December 2022, and worse than every estimate in the Bloomberg survey of economists. The National Bureau of Statistics stated that “the economy faced a number of challenges” in November and “there were many external instabilities and uncertainties, and domestic demand was insufficient”. The slowdown in November’s consumption growth was likely caused in part by unfavourable statistical effects given China began rolling out government subsidies for household purchases of consumer goods in late 2024 creating a high base of comparison. Furthermore, an earlier-than-usual start of the Singles’ Day promotion probably brought forward some purchases to October from November.

Nevertheless, the soft consumption reading continues to highlight that China’s economy remains too reliant on external demand and more needs to be done to boost domestic demand. Persistent housing market weakness remains a headwind to growth. At policy meetings held last week, China’s top leaders listed boosting domestic demand as the top priority in the new year. The government is expected to set a similar annual growth target for next year at around 5%. Overall, the soft monthly activity data for November will damp expectations for further renminbi upside. Recently, domestic policymakers have become more tolerant of allowing the renminbi to strengthen as downside risk from trade disruption have eased, and China’s trade surplus has risen to a new record high. USD/CNY has continued to decline overnight dropping back below the 7.0500-level for the first time since October of last year.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com