The fate of the Japanese yen could hinge on Friday’s inflation report, as rising price pressures and stronger wage growth increase the likelihood of a Bank of Japan (BOJ) rate hike. Markets may be underestimating the risk of tighter policy, setting the stage for a potential yen rally against the U.S. dollar.

Inflation Report in Focus

Japan’s upcoming nationwide inflation report will be closely watched after Tokyo’s latest inflation figures revealed persistent price pressures. Core inflation in the capital surged to 2.5% in January, the fastest pace in nearly a year, marking a third consecutive month of acceleration. The rise keeps inflation well above the BOJ’s 2% target and strengthens the case for continued policy tightening.

Should the nationwide inflation report follow Tokyo’s trend, the BOJ may be forced to act sooner than expected to control inflation, pushing the yen higher against the dollar.

Rising Wages Add to Inflationary Pressures

Beyond inflation, Japan’s Shuntō wage negotiations in March could further fuel expectations of a BOJ rate hike. In 2024, labor unions secured the largest pay raises in decades, prompting the BOJ to exit negative interest rate policy. This year, unions are pushing for even higher wage increases, with major firms expected to grant raises of 5-6%.

Higher wages would support domestic consumption, adding to inflationary pressures and increasing the likelihood of further BOJ policy tightening. However, swaps markets remain skeptical, pricing in just a 25% chance of a rate hike by May and fully pricing in only one 25bp hike by September.

USD/JPY Faces Key Technical Levels

Despite higher U.S. Treasury yields, USD/JPY has struggled to break higher, signaling potential weakness. The pair remains vulnerable to a downside break, with support at 151. A clean break below this level could trigger an unwind to 148.65, the December low.

Recent technical signals suggest increasing downside risks:

• Bearish engulfing candles and repeated rejections at downtrend resistance.
• MACD trending lower, indicating fading bullish momentum.
• RSI divergence, showing weakening upside pressure.

If USD/JPY closes below 151, the yen could strengthen further, challenging key support levels. On the upside, resistance remains at 152.43 and 153.38, with short-term bounces potentially offering new short-selling opportunities.

Shifting Market Drivers

Unlike previous cycles, recent USD/JPY price action has been driven more by Japan’s rate expectations rather than the Federal Reserve’s outlook. The correlation between short-term Japanese yields and USD/JPY has strengthened, meaning a hawkish BOJ shift could drive a sharper yen rally.

With inflation pressures building and BOJ commentary turning more hawkish, markets may be underestimating the risk of further rate hikes, potentially setting the stage for a stronger JPY rebound in the coming months.