The USD/JPY pair continues to consolidate near the 160.00 level at the start of the week, as market participants await the Bank of Japan’s policy meeting scheduled for tomorrow.
The yen received short-term support from Middle East developments. Reports of an imminent reopening of the Strait of Hormuz triggered a drop in oil prices to a two-month low. For Japan, which is heavily dependent on energy imports, lower oil prices ease inflationary pressure and reduce the burden on the trade balance.
Tomorrow, traders’ focus will be on the Bank of Japan’s interest rate decision. Markets are pricing in the possibility of a rate hike to 1%, as the regulator seeks to contain domestic inflation and normalize monetary policy after a prolonged period of accommodative conditions.
Pressure on USD/JPY has also intensified due to dollar weakness. Investors have revised their forecasts regarding Federal Reserve rate changes following reports that the US and the Islamic Republic have reached an agreement to end the conflict. The easing of geopolitical tensions has reduced fears of a new oil-driven inflation surge and weakened the case for a more hawkish policy stance.
Following the announcement of the historic agreement between Washington and Tehran, the CME FedWatch tool now indicates nearly a 47% probability that the US regulator will keep interest rates unchanged through the end of the year. Recall that just a week earlier, this probability was estimated at only 28%.
Against this backdrop, the yen continues to balance between an improving external environment and expectations of Bank of Japan policy tightening. The regulator is expected to raise the benchmark interest rate to its highest level since 1995. Since Tuesday’s decision is almost fully priced in, investor attention will focus less on the rate hike itself and more on the subsequent press conference, which this time will be held without Bank of Japan Governor Ueda. If the regulator confirms its readiness for further policy normalization, the yen could receive additional support.
