USD/JPY: It’s all about the inflation - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that the week ahead will bring, amongst other key economic events, the June releases of US PPI and CPI inflation data which is likely to have significant impact on the direction of USD/JPY pair.

Key Quotes

“The issues of weak growth combined with low inflation that have dogged the Japanese economy since the 1990s were for a long time regarded as specific to Japan.  However, since the financial crisis this experience was shared by much of the G10 meaning that the lessons learnt by Japan have a wider relevance.  In a speech made last month BoJ Kuroda explains many of the challenges faced the BoJ in tackling low inflation.  He refers to BoJ analysis that suggests that “as a result of prolonged deflation, the backward-looking, or adaptive, component in the formation of inflation expectations continues to be much stronger in Japan than in Europe and the United States. Therefore, if, for whatever reason, the observed inflation rate declines -- even if only temporarily - this will tend to drag down inflation expectations”.”

“In other words since inflation rates have been low for so long, the Japanese population are not inclined to believe that prices will rise in the future.  There is a clear risk that this psychology could spread to other countries within the G10.  Expectations that low inflation will prevail can lead to purchases being delayed and can have a detrimental impact on overall consumption levels and economic growth.  A backdrop of too weak price pressures can also lead to low wage rise agreements which will also lessen demand growth and inflation and lead to a self-perpetuating cycle.  For a variety of reasons, low wage growth is already an issue in most of the G10, suggesting that Japan’s low inflation psychology may already have spread.”

“In view of the fact that wage growth and inflation is still lower in the US than would normally be expected at this point of the economic cycle, we do not expect that the US will hike rates again this year.  For this reason we expect a soggy performance for the USD in the months ahead.  Although Kuroda’s dovish rhetoric has ensured the yen has been the worst performing G10 currency over the past month, we see USD/JPY as currently trading close to the top of its range.  The May high in the 114.37 area is likely to offer resistance though a break higher would signal a move towards the psychological 115 level.”