USD/JPY softens on hawkish BoJ hold

Bank of Japan holds rates

The Bank of Japan maintained interest rates at around 0.75% for a third straight meeting as it assesses the economic impact of the Middle East conflict. Three members opted for a hike, leading to a 6-3 vote split that underscores the challenging situation and growing divisions around the appropriate stance ^[1]. Despite this divergence, the central bank maintained its tightening bias, saying it "will continue to raise" interest rates. ^[2]

Policymakers also raised their inflation forecasts and lowered the growth outlook, highlighting the impact of the energy shock from the US-Iran conflict. Median core CPI is now expected to increase 2.8% in the current fiscal year (from 1.9%). Core-core CPI, which excludes both food and fuel prices, was also revised up to 2.6% (from 2.2%), while GDP was downgraded to +0.5% (from +1%).

The Middle East conflict sparks stagflation risks

The closure of the Strait of Hormuz has fuelled a spike in energy prices, with Japan particularly exposed as a net oil importer sourcing 94% of its supply from the Middle East ^[3]. Core CPI rose to 1.8% in March, reversing a recent deceleration, and inflationary pressures are expected to persist as the Strait has remained closed for a prolonged period, exacerbating existing trends.

Real wages rose 1.9% y/y in February, marking the second consecutive expansion and the highest level since 2021. Wage increases are also expected to stay above 5% for a third straight year, with Rengo pointing to a 5.08% average rise for FY26 so far ^[4]. Policymakers expect the wage-price virtuous cycle to be maintained.

On the other hand, the spike in oil prices is weighing on an economy already grappling with US tariffs. The shock could affect consumption and Japan's manufacturing base, even threatening the energy-sensitive chips industry. Alluding to these headwinds, the central bank sees private consumption, exports and production "more or less" flat.

Nonetheless, a world-class chips industry benefiting from the AI boom supports economic activity, just as PM Takaichi's expansionary fiscal policies can help growth and consumer spending. The budget for the current fiscal year rose to a record ¥122.3 trillion, with a 2% increase in social security expenditures and a 4% jump in defence spending. ^[5]

USD/JPY outlook

The guidance for further rate increases, the upgraded inflation forecasts and the vote split provide a hawkish backdrop, setting the stage for a resumption of rate hikes. As a result, USD/JPY slips today and could be in for deeper pullbacks below the 38.2% Fibonacci level. The BoJ decision underscores an unfavourable monetary policy differential: while markets may have priced out Fed rate cuts, its Japanese counterpart is firmly on a tightening path.

On the other hand, USD/JPY maintains its upside bias, staying on track for new multi-decade highs. The BoJ will need to tread carefully as a fragile economy grapples with fresh headwinds from the Middle East conflict.

Moreover, the yen continues to be weighed down by concerns over Japan's public finances, and the higher FY26 budget plays into these fears, particularly given that Japan remains one of the most indebted countries in the world ^[6]. This has prevented the yen from benefiting from risk aversion, with the USDOLLAR dominating safe-haven flows during this turbulent period.

Still, FX intervention risks remain and can continue to cap the upside, with 160.00 often viewed by markets as the line in the sand. Just before the BoJ decision, Finance Minister Katayama reiterated readiness to act, according to Bloomberg. ^[7]