Yen gains strength on hawkish BOJ outlook

Important calendar events

• USD: S&P/CS Composite-20 HPI, HPI

USD

The dollar remained steady on Monday, and the index hovered close to the 108.1 level. US treasury yields declined, with the US 10-year bond yield dropping from 4.63% to 4.54%. Forex markets were quiet on Monday ahead of New Year’s Eve. 

At its latest meeting, the US Federal Reserve cut interest rates by 25 basis points to a target range of 4.25% to 4.50%. Fed Chair Jerome Powell delivered a hawkish message after the policy meeting, emphasizing the need to be cautious about further rate cuts. Powell stated that the Fed’s approach will remain data-driven and hinted that future rate cuts will be slower, as inflation in the US remains above the central bank’s 2% target. 

The Fed’s latest dot plot indicated that only two rate cuts will take place in 2025, down from four projected in September. In quantitative terms, policymakers expect to deliver a total of 50 basis points of rate cuts in 2025, which will bring the central bank’s interest rate to 3.9% by the end of 2025, which is significantly higher than the 3.4% estimated in September. 

US inflation is proving to be sticky despite the Federal Reserve’s efforts to bring it down to its 2.0% target. US Headline inflation rose to 2.7% year-on-year in November from 2.6% in October. Monthly inflation rose by 0.3% in November, the same as in October, which was in line with expectations. Core CPI, which excludes food and energy, rose by 0.3% in November. 

Final GDP data for the third quarter of the year showed that the US economy expanded by 3.1% in the third quarter of 2024, up from 2.8% estimated earlier. In addition, the US economy expanded by 3.0% in the second quarter of the year and by 1.4% in the first quarter of the year. 

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EUR 

EUR/USD traded sideways on Monday, oscillating around the 1.041 level. If the EUR/USD pair declines, it may find support at 1.034, while resistance may be encountered near 1.045.

The ECB lowered its benchmark interest rate by 25 basis points in December, bringing its main refinancing rate to 3.15%. This was the fourth rate cut for the ECB this year, which started its easing cycle in June and has already lowered interest rates by a total of 100 bps. More importantly, ECB President Christine Lagarde hinted at further easing in the coming months as Eurozone inflation nears the central bank’s target while the economy remains weak.

Lagarde’s press conference after the policy meeting was dovish, raising expectations of further rate cuts. The central bank is currently expected to cut interest rates up to five more times next year, to a total of 125bps, until neutral policy settings are reached. Expectations that the ECB will return to a more normalized policy setting sooner than the Fed, are putting pressure on the EUR/USD rate. 

Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates in December. Eurozone inflation rose to 2.3% year-on-year in November from 2.0% in October, which was in line with expectations. Core CPI, which excludes food and energy, remained steady at 2.7% in November, against expectations of a 2.8% print. 

Flash GDP data showed that the Eurozone economy expanded by 0.4% in Q3 of 2024, rising from 0.2% in Q2. The Eurozone economy also expanded by 0.3% in the first quarter of 2024. The economic outlook of the EU remains fragile as prolonged tightening has brought the Euro area economy to the brink of recession.

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GBP 

GBP/USD dropped from 1.261 to 1.251 in early trading on Monday, but partly recovered towards the end of the day, rising to 1.255. If the GBP/USD rate goes up, it may encounter resistance at 1.261, while support may be found near 1.247.  

The BOE kept interest rates steady at its latest policy meeting, having cut interest rates twice already this year. MPC members voted 6-3 to keep rates on hold, with three members in favor of cutting interest rates. Last week’s MPC voting shows a shift to a hawkish direction, as policymakers had voted with a strong majority of 8-1 to cut rates to 4.75% in October. 

Bank of England Governor Andrew Bailey reiterated his former message that the central bank needs to adopt a gradual approach to future rate cuts. Bailey also stressed that the BOE’s policy outlook will remain data-driven and refused to commit to a timeline or magnitude of future rate cuts.  

CPI data showed an uptick in British inflation in November. Headline inflation in the UK rose to 2.6% year-on-year in November from 2.3% in October. Core annual inflation, which excludes food and energy, climbed to 3.5% in November from 3.2% in October against 3.6% anticipated. 

Final GDP data for the third quarter of the year showed that the British economy is stagnating. Earlier forecasts indicated slight economic growth by 0.1% in the third quarter of 2024, but the British economy is being stifled by high interest rates and cannot expand. 

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JPY

USD/JPY dipped on Monday, dropping from 157.9 to 156.9 as the Yen gained strength. If the USD/JPY pair declines, it may find support at 155.9. If the pair climbs, it may find resistance at 158.8. 

The BOJ maintained its current monetary policy guidelines steady and its interest rate at 0.25% at its latest policy meeting. BOJ policymakers decided to keep rates unchanged in an 8-1 vote split, as one member voted in favor of a 25-bps hike. BOJ Governor Kazuo Ueda stated that Japan’s economic and inflationary outlook remains uncertain and stressed that the central bank’s policy will remain data-driven. 

The minutes of the latest BOJ meeting were released on Friday and were more hawkish than anticipated, boosting the Yen. The Yen continued to gain strength on Monday as market odds of BOJ rate hikes continued to rise. The minutes showed that policymakers expressed different opinions on the central bank’s rate outlook, with several members speaking in favor of gradual rate hikes. Other BOJ members emphasized the difficulty in predicting a rate hike path, due to changing economic and inflationary conditions.

Odds of a BOJ rate hike in December are still below 50% but markets are pricing in a total of 50 basis points’ worth of rate cut by the end of March.

Inflation in Japan is on the rise, raising the odds of future rate hikes and providing support for the Yen. The headline Tokyo CPI inflation rose to 3.0% annually in December, up from 2.6% in November. Headline inflation in Japan rose by 2.7% year-on-year in November from 2.3% in October against expectations of a 2.6% print. In addition, BOJ Core CPI rose to 1.7% year-on-year in November from 1.5% in October against expectations of 1.5%. 

Final GDP data for the third quarter of the year showed that Japan’s economy expanded by 0.3%, exceeding initial estimates of 0.2%, but down from 0.7% in the second quarter. The Japanese economy is expanding, after shrinking by 0.5% in the first quarter of the year. 

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Written by:
Myrsini Giannouli

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