US Inflation Relief Affects Dollar and Yen Ahead of BOJ Meeting

By Tom Westbrook

SINGAPORE (Reuters) - On Thursday, the dollar saw a decrease, stepping back from its recent highs as U.S. inflation data showed signs of cooling. This eased bond yields, while the yen gained strength, reaching a one-month peak amid increasing speculation about a rate hike in Japan.

The yen emerged as the most significant mover in the forex market, appreciating by approximately 1% due to shifting market sentiments. As concerns about U.S. inflation eased, traders began to anticipate Federal Reserve rate cuts, coinciding with expectations that the Bank of Japan might raise rates in its meeting next week.

At one point, the yen reached 155.21 against the dollar, marking its strongest position since December 19. The U.S. dollar also retreated against the Australian and New Zealand dollars, briefly touching a one-week low against the Australian dollar at $0.6248 in early Asian trading.

The euro remained relatively stable, trading at $1.0298. In contrast, the dollar continued its downward trend for the fourth consecutive session, easing further to 109.02 against the Japanese yen.

Despite the announcement of a ceasefire deal in Gaza, foreign exchange markets showed little direct reaction, although the shekel did rise to a one-month high.

According to recent reports, core U.S. inflation recordings showed a month-on-month increase of 0.2% in December, which aligned with forecasts and was below November's figure of 0.3%. The annualized rate also appeared more favorable at 3.2%, falling short of the anticipated 3.3%. This came after a similarly soft inflation report from the UK and comments from a Bank of England official suggesting a readiness to lower interest rates.

The market responded positively to the inflation data, with traders buying stocks and reducing benchmark 10-year Treasury yields by more than 13 basis points, albeit the currency market's reaction was somewhat subdued.

Even with the dip, the dollar index was still up 0.5% for January. If this trend continues, it could result in four months of consecutive gains for the dollar. Post-inflation data, the markets adjusted their expectations for Federal Reserve easing to account for around 10 basis points of cuts this year, with an overall estimate of 37 basis points.

Deutsche Bank macro strategist Tim Baker commented, "The dollar has indeed overshot rate spreads recently, although the deviation is not excessively large. There is a need for the dollar to accommodate a risk premium under the current geopolitical conditions. Historically, the dollar has shown strength when U.S. economic growth outpaces that of other countries, often overshooting this relationship in such scenarios."

Looking ahead, markets are cautious as they await Donald Trump's inauguration day on Monday, which is expected to bring several executive orders that may affect tariffs significantly, potentially disrupting asset prices and the dollar's trajectory.

Mizuho economist Vishnu Varathan noted, "Dollar strength might partially stem from fears surrounding Trump’s tariffs and other policies."

The Chinese yuan found itself under pressure, trading near the weaker end of its trading range at 7.3312 early in the day. The New Zealand dollar lingered at $0.5623, staying close to the two-year low it hit at $0.5543 on Monday, while the Australian dollar closely approached its five-year low, only receiving a modest boost from promising employment data earlier this week.

The British pound slightly dipped to $1.2233 in Asia, and smaller currencies did not fare much better. For instance, Indonesia's rupiah reached a six-month low on Wednesday following an unexpected rate cut from Bank Indonesia. South Korea's won remained unchanged despite the central bank's decision to maintain its benchmark rate at 3% on Thursday, contrary to market expectations.

In addition to monitoring the upcoming inauguration, markets are also focused on the Chinese growth figures set to be released Friday, along with the Bank of Japan meeting scheduled for next week. Recent comments from BOJ Governor Kazuo Ueda and Deputy Ryozo Himino have indicated that a rate hike will be on the agenda, with markets estimating about a 74% likelihood of a 25 basis point increase in short-term rates to 0.5%.

inflation, dollar, yen