Yen Drops to 160 vs Dollar, December Rate Hike Looms

In the past week, the Japanese yen has seen a notable uptick in its value against the US dollar. By November 28, the yen had appreciated over 2.1% against the dollar, outperforming other currencies within the G10 group. This marks the first significant gain for the yen since late July of this year, indicating a shift in market sentiment and trading strategies.

Analysts have suggested that traders are anticipating a narrowing gap between US and Japanese government bond yields in the coming month, which has contributed to the yen's rise. Some strategists argue that there is further potential for the yen to strengthen, particularly as overnight swap indices suggest a greater than 60% likelihood of a rate hike in Japan and a corresponding decrease in US rates.

Despite this optimistic outlook, several analysts remain cautious about the yen’s potential for continued appreciation. Goldman Sachs has revised its forecasts for the dollar-yen exchange rate, raising its expected value from 149 to 159 yen over the next year. The depreciation of the yen throughout this year has already led to higher import prices since the summer, underscoring the complexities of currency fluctuations in the Japanese economy. With the dollar-yen rate projected to hold steady above the 150-yen mark, Goldman Sachs anticipates that Japan's core Consumer Price Index (CPI) will rise by 2.1% year-on-year in 2025, and 2.0% in 2026, slightly exceeding the Bank of Japan’s target.

Advertisement

In its 2025 economic outlook report on Japan, Goldman Sachs delves into the potential impact of the yen's volatility on the Bank of Japan's monetary policy. The firm suggests that if the yen depreciates to around 160 to the dollar, the next interest rate hike could be moved up from January 2025 to December 2024. This prediction reflects a changing landscape where Japan’s active inflation rates and an ongoing economic recovery could pave the way for a normalization of monetary policy.

Japan is gradually emerging from a prolonged period of deflation, which had historically stifled its economic growth. The recent stabilization in inflation rates is a significant development. In October, Japan's overall inflation rate declined to 2.3%, marking its lowest level since January and falling below September's rate of 2.5%. Notably, this figure still exceeded economists' expectations of 2.2%. In addition to meeting inflation targets, Japanese businesses have also increased wages. According to a government survey, amid rising prices, the average monthly salary for Japanese workers saw an increment of 2,524 yen (approximately $16), reaching a record 11,961 yen, a notable milestone as it surpassed the 10,000 yen threshold for the first time.

The Goldman Sachs report further predicts that during the wage negotiations set for the spring of 2025, the basic wage growth rate will hover between 3% to 3.5%, slightly lower than the previous year's rate of 3.6%, yet still indicating a conducive environment for a virtuous “wage-price spiral.” This shift signifies a potential anchoring of inflation expectations, which would be beneficial for the Japanese economy. Goldman Sachs posits that forthcoming CPI data in Japan will reflect the impact of wage increases on service prices, showcasing a significant transition in the economic landscape where the economy has crossed the threshold of sustainable inflation.

The interrelationship between rising wages and service pricing is crucial; as wages climb, the prices for services are likely to follow suit. Analysts caution that future cost pressures stemming from direct and indirect wage increases could intensify, especially within labor-intensive service sectors. Goldman Sachs estimates that should labor costs and service prices increase by 3%, it could lead to an overall CPI rise of between 1.1% and 1.5%, underscoring the importance of this dynamic for ensuring sustained inflation moving forward.

Expectations for the normalization of monetary policy have been infused with renewed vigor this week, following traders' predictions of a contraction in the yield gap between the US and Japan. Earlier comments from Bank of Japan Governor Kazuo Ueda have left the door open for potential rate hikes, reinforcing his stance of a “data-dependent” policy approach. He indicated that the timing of any future adjustments would depend primarily on the evolving economic and price conditions in Japan. Currently, traders are gearing up for a potential rate increase from the Bank of Japan next month.

The forecast highlights an acceleration of Japan’s economic recovery projected for 2025, with real GDP growth anticipated at 1.2% (exceeding the potential growth rate of 0.7%) and nominal GDP growth soaring to 3.4%, more than double the average of 1.6% observed from 2013 to 2019. This growth surge in nominal GDP suggests that recent economic growth in Japan has been largely driven by price-related factors rather than broad-based economic advancements.

Goldman Sachs also elaborates on its predictions regarding the Bank of Japan's interest rate trajectory, foreseeing rate hikes of 25 basis points each in January and July of the upcoming year. By the end of 2025, they project the policy rate could reach 0.75%, with a continued upward trend likely to see rates peak at 1.5% by 2027. Should the yen depreciate towards the 160-yen mark against the dollar, they predict that the anticipated interest hike could potentially be advanced from January 2025 to December of this year, further shaping the future of Japan’s monetary landscape.