Behind the Yen's depreciation to 156.49: Tokyo inflation data unexpectedly "cooled down," triggering expectations of delayed BOJ interest rate hikes

Important signals have emerged from the Asian market on December 26 — the pace of the Bank of Japan’s next policy move may be about to change. Along with an unexpected decline in inflation data in the Tokyo area, the yen depreciated rapidly against the dollar to 156.49, significantly lower than the 155.80 before the data was released. Behind this sharp currency market volatility is the reality that Japan’s inflation pressures are receding faster than expected.

Inflation Data Falls Short of Expectations, Food and Energy Price Pressures Significantly Eased

According to the latest data released by Japan’s Statistics Bureau, the consumer price index (CPI) in Tokyo excluding fresh food rose by 2.3% year-on-year in December, a notable slowdown from the previous month’s 2.8%. This decline marks the lowest since August, mainly due to the fading base effects from the termination of energy subsidy policies last year. Economists had generally predicted this indicator would stabilize around 2.5%, but the actual result far exceeded pessimistic forecasts.

Meanwhile, the overall inflation rate also dropped sharply from 2.7% in the same period last year to 2%, with core inflation (excluding energy) slowing to 2.6%. These data indicate that price increases in goods, services, and especially food are all clearly converging. Koya Miyamae, senior economist at SMBC Nikko Securities, pointed out that some food sellers, after experiencing significant price hikes earlier, have begun a price reduction cycle, and with demand stagnation, retail promotional efforts are also intensifying.

Recent BOJ Rate Hike Decision Faces New Variables

Less than a week ago, the Bank of Japan’s Policy Board unanimously voted to raise the policy rate to 0.75%, the highest since 1995. BOJ Governor Kazuo Ueda stated at a subsequent press conference that if price trends proceed as expected, further tightening policies would be implemented, but he remained vague about the pace of rate hikes and the ultimate rate level.

The unexpected decline in inflation data has subtly shifted market expectations regarding the BOJ’s future policy path. Although the 2.3% core inflation remains above the BOJ’s 2% target, the slowdown provides the central bank with more flexibility in policy decisions.

Exchange Rate Fluctuations Reflect Market Pricing of Rate Hike Delays

The rapid depreciation of the yen essentially reflects market participants’ pricing of a delay in the BOJ’s rate hikes. Economists surveyed by Bloomberg generally expect the BOJ to raise rates roughly once every six months, with a terminal rate around 1.25% — meaning about two more rate hikes are needed in this cycle.

However, the weak inflation data shortens the certainty of the next rate hike. The challenge for the yen’s depreciation is that excessive weakening could raise import costs, which through cost-push mechanisms could push up domestic prices, creating a counterproductive effect against the BOJ’s policy goals. This conflicting situation has led Japanese officials to frequently state that they are prepared to intervene in the foreign exchange market if necessary.

Tokyo Inflation as a Leading Indicator for Nationwide Trends

Tokyo’s consumer price data has long been regarded as a leading indicator of nationwide inflation trends. The significant weakening of this data suggests that inflationary pressures across the country are on a clearer downward trajectory. Against this backdrop, the BOJ’s latest policy statement projects that inflation will only reach its target level in the latter half of the forecast period, extending into fiscal year 2027 — a wording that effectively leaves ample room for adjusting the pace of rate hikes.

Markets are closely monitoring subsequent price developments to determine when the BOJ might restart its rate hike cycle. The yen remains near its lowest levels since January against the dollar, and official warnings of foreign exchange interventions indicate that concerns over Japan’s export competitiveness have become an important reference in current policy considerations.