USD/JPY rallies on US data, Friday wage survey key to BoJ decision

• USD/JPY surges after US inflation data comes out hotter than expected. 
• Upside could be capped, however, by expectations of an impending rate cut by the BoJ. 
• The outcome could depend on the results of a preliminary survey of wage agreements published Friday. 

USD/JPY is trading in the lower 148.00s during the US session on Thursday, up over a third of percentage point after the release of US macroeconomic data.

An unexpected rise in US Producer Prices (PPI) indicates inflation remains stubbornly high and the Federal Reserve (Fed) will need to keep interest rates elevated for longer to combat it. 

The maintenance of higher interest rates is positive for the US Dollar (USD) and USD/JPY, because relatively higher interest rates attract greater inflows of foreign capital.   

Previously, markets had been pricing in the possibility of the Fed cutting interest rates in May or June, however, following the release of Thursday’s PPI data, the probability of the rate cut in May has dwindled to 9%, according to the CME Group’s FedWatch Tool, which calculates the probabilities of changes in the Fed Funds Rate based on the price of Fed Funds Futures.

The probability of a June rate cut remains relatively high at 62%, but still down from over 70% recorded a few days ago.  

Upside for the USD/JPY could be capped by expectations the Bank of Japan (BoJ) will raise interest rates at their March meeting next Tuesday. Such a move would end decades of ultra-loose policy and be the first time since February 2007 the bank has increased interest rates. The expected move comes after higher inflation in Japan and the potential for further price pressures after a series of higher wage agreements between major labor unions and employers. 

The Chairman of the Bank of Japan, Kazuo Ueda has consistently said that he will only agree to higher interest rates if the inflation rate sustainably reaches the BoJ’s 2.0% target. Currently headline inflation sits above the target at 2.2% whilst core inflation is at 2.0% – exactly at the target level – from 2.3% in the previous month.  

The BoJ has said its decision whether or not to raise rates next Tuesday could hinge on the preliminary results of a survey of big firms' wage talks published on Friday, March 15, according to the Asahi Shimbun.