Japan Week Ahead: Yen’s Weakness Persists, Keeping Imports Expensive, Producer Costs High Despite Recent Easing in Global Crude Oil Prices

–BOJ Set to Continue Raising Policy Rate but U.S.-Japan Rate Gap Remains Wide, Exerting Downward Pressure on Yen Vs. Dollar

By Max Sato

(MaceNews) – The depreciation of the yen has lingered on expectations that the U.S. Federal Reserve will have to raise interest rates by the end of the year to rein in inflation and thus that dollar assets will remain attractive with much higher returns than those on yen-denominated securities.

Bank of Japan policymakers have said they will continue to raise the policy interest rate as part of the gradual process of reducing the effects of the bank’s large monetary stimulus. After conducting their fifth rate hike in the current cycle in June, BOJ officials also noted that underlying consumer inflation is nearing the bank’s 2% price stability target.

The U.S.-Japan interest rate differential remains wide. Last month the Federal Open Market Committee decided to maintain the target range for the federal funds rate at 3.5% to 3.75%, which is still well above the BOJ’s target for the overnight interest rate at 1%, which was raised from 0.75%. The bank estimates the rate that is neutral to economic activity is somewhere between 1.1% and 2.5%.

Judging from the pace of gradual policy rate adjustment by the BOJ since its first rate hike in 17 years in March 2024, another 25-basis point increase is widely expected by the Dec. 17-18 meeting, six months after the latest policy action on June 15-16. Governor Kazuo Ueda has said the bank will ensure that it will not fall behind the curve in raising rates amid growing upside risks to inflation.

Bond market participants have been sensitive to how Japanese government leaders describe the fiscal and monetary policy coordination framework, reacting to the draft of this year’s basic policy on economic and fiscal management and reform released by the government on June 30.

The yield on 10-year government bonds, a key indicator of borrowing costs for households and businesses, briefly hit a 29-year high of 2.81% on July 3 as bond selling emerged amid concerns that the government may be tacitly telling BOJ policymakers to slow the pace of rate hikes, which in turn could allow inflation to accelerate and erode returns on fixed income securities. Market participants are also wondering how the government will finance multi-year large spending on programs to spur new growth areas and revive declining industries.

In the draft, the government stressed the administration of Prime Minister Sanae Takaichi aims to achieve a “strong economy,” and to that end, “it is extremely important to implement appropriate monetary policy that contributes to achieving ‘stable inflation.’”

“We expect the Bank of Japan, in accordance with Article 4 of the Bank of Japan Act and the spirit of the joint statement, to work closely with the government and, while confirming a virtuous cycle of wages and prices, to conduct appropriate monetary policy aimed at achieving the 2% price stability target in a sustained and stable manner,” the draft said.

The latter part on close coordination is nothing new. It has been repeated in the government’s monthly economic report. What drew market attention was the reference to the Bank of Japan Act, which calls on the central bank to “always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government’s economic policy are mutually compatible.”

As for the joint statement, it dates back to January 2013, when Masaaki Shirakawa, then governor of the bank, agreed to set an explicit 2% inflation target and try to achieve it with monetary easing under pressure from conservative ruling party lawmakers who hinted that they could make the central bank less independence of political influences by rewriting the law. In exchange for the new target, government leaders agreed to state that they would work on fiscal consolidation and structural reforms.

In a recent interview with the public broadcaster NHK, Shirakawa warned that the yen’s value measured by the real effective exchange rate has been declining constantly since 1995 to the level seen in 1970 when the nominal dollar/yen exchange rate was fixed at ¥360. He said the decline essentially reflects Japan’s fragile economic conditions: reduced exporter competitiveness and sluggish domestic business investment amid the falling population. “We have to take seriously,” he said.

Shirakawa called for a faster pace of BOJ rate hikes to unwind large-scale monetary stimulus that had accumulated in a decade from 2013, when he retired and was replaced by Haruhiko Kuroda, a former top Ministry of Finance official who shared a reflationary theory with the then Prime Minister Shinzo Abe.

Prime Minister Takaichi, who has expressed support for Abe’s idea of boosting the economy with monetary easing and fiscal spending, has been careful not to publicly comment on what the BOJ should do but news reports said she was not happy with the BOJ rate hikes as they will boost the government’s borrowing costs when she wants to push ahead with a public-private investment plan exceeding ¥370 trillion through fiscal 2040.

The recent slide in global crude oil prices to around pre-Iran war levels is good news for households and businesses but the stubbornly weak value of the yen will continue to keep import costs high.

Japan’s efforts to diversify the sources of crude oil and naphtha from the Middle East appear to have eased domestic shortages of materials, at least temporarily, and supported business confidence in the BOJ’s quarterly Tankan survey released last week but the remaining impact of the Mideast conflict is expected to be felt in June producer prices data.

The median forecast of a 6.6% year-on-year increase in the corporate goods price index would be an acceleration from a 6.3% rise in May and remain the highest since 7.4% recorded in March 2023.

The costs of essential goods are stuck at high levels, keeping consumers cautious, and household spending for May is forecast to post its sixth straight year-on-year dip. Consumer inflation has stayed below the BOJ’s 2% target in recent months but that is because of temporary effects of fiscal measures: fuel subsidies aimed at easing the impact of the Mideast conflict as well as free high school education that took effect in April.

Tuesday, July 7
0830 JST (2330 GMT/1930 EDT Monday, July 6) The Ministry of Internal Affairs and Communications releases May household spending.
Mace News median forecasts: -2.3% y/y (range: -2.6% to +0.3%) vs. Apr -0.5%; +1.9% m/m (range: +1.2% to +2.5%) vs. Apr +1.6%

Japan’s real average household spending is expected to post a sixth straight year-on-year drop in May, down 2.3%, after a slight 0.5% dip in April, as consumers remain cautious amid elevated costs of living. It is also in payback for a 4.7% jump in May 2025, which was driven mainly by vehicle purchases after the supply of new vehicles had recovered from suspended output at Toyota group factories over safety check scandals. At the time there was also post-pandemic pickup in eating out and strong demand for air conditioners.

The Mideast conflict and the depreciation of the yen have kept import and production costs high, which are expected to have more spillover effects on consumer prices in coming months. The average real wages have crawled above year-earlier levels in recent months as large firms are raising wages to secure qualified employees but those working for smaller firms feel the pace of pay increase is not catching up with inflation. 

The expected decrease is likely to be partly offset by solid replacement demand for air conditioners ahead of April 2027 when the government is scheduled to introduce stricter energy saving standards.

On the month, real average expenditures by households with two or more people are forecast to market another month of a strong gain, up 1.9%, after rising 1.6% in April, slumping 1.3% in March and rebounding 1.5% in February.

Many households have been spending less on eating out and offering smaller amounts of gift money at weddings while they have paid higher medical and dental bills in recent months. Inflation is also hurting households. There is also a widespread move to switch to more affordable mobile communications plans.

On the supply side, official data released last week showed that retail sales surged 5.3% rise on the year in May, coming in much stronger than expected and hitting the highest pace since 5.4% in November 2023, as demand for vehicles, particularly used ones, continued to pick up, booming stock prices prompted consumers to shop for luxury goods and hot weather appeared to have boosted sales of air conditioners and fans.

Industry data showed department store sales posted their fifth straight year-on-year increase in May, up 8.3%, accelerating from a 5.2% gain in April, as spending by visitors from overseas marked a double-digit percentage jump (+16.7%) as seen in the previous month (+18.3%). There was one more public holiday and one more Sunday compared to a year earlier, which led to solid sales to domestic customers.

The yen remains stubbornly weak despite rounds of currency market intervention by the Ministry of Finance from late April to early May, which supported the purchasing power of visitors from Hong Kong, Taiwan, Malaysia and Singapore, offsetting a 5% drop in spending by Chinese tourists.

Tuesday, July 7
1400 JST (0500 GMT/0100 EDT Tuesday, July 7) The Bank of Japan releases the May consumption activity index. The supply-side indicator, which has a close correlation with revised GDP data, rebounded a real 1.6% on the month in April on a travel balance adjusted basis, after falling 0.4% in March. The April figure posted a 1.3% rise on the January-March quarter, when the index gained 0.6%.

Thursday, July 9
– Bank of Japan branch managers gather at the Tokyo head office for a quarterly meeting to discuss regional economic conditions. In the last regional economic report issued in April, all nine regions described their economies as either recovering moderately, picking up or picking up moderately while five regions continued to note that there were some soft spots. Branch mangers also reported that the spike in crude oil prices and supply chain restraints caused by the Middle East conflict had begun to push up operational costs and lower capacity utilization.

Friday, July 10
0830 JST (2350 GMT/1930 EDT Thursday, July 9) The Bank of Japan releases the June corporate goods price index (CGPI).
Mace News median: CGPI +6.6% y/y (range: +6.4% to +7.2%) vs. May +6.3%; +0.2% m/m (range: +0.0% to +0.7%) vs. May +0.9%

Producer inflation in Japan is expected to continue accelerating to 6.6% in June from 6.3% in May and 5.3% rise in April as energy and transportation costs remained above year-earlier levels and the weak yen kept imports expensive even though crude oil prices had slid to pre-Iran war levels and domestic shortages of naphtha and other materials had eased. The 6.6% year-on-year increase in the corporate goods price index would be the highest since 7.4% recorded in March 2023.

Japan has increased purchases of crude oil and naphtha, the key material for producing plastics and resins, from the United States and other countries to bypass the Middle East. This should help bring the month-on-month increase in the CGPI down to a slower pace of 0.2% after marking sharp gains of 0.9% in May and 2.8% in April, which were driven by high costs of fuels, utilities and petrochemical products.