Weak yen, combined with rising oil costs due to the Ukraine conflict, has led to cost-push inflation in Japan. Japanese PM contender and Chief Cabinet Secretary, Hayashi, mentioned the Bank of Japan’s monetary policy aligns closely with government perspectives, noting a reduced concern over a strong yen.
Hayashi acknowledged the risk that a Federal Reserve rate cut might strengthen the yen against the dollar, potentially affecting Japan’s export-focused economy. He stated the weak yen, alongside escalating oil expenses, has contributed to inflation.
Economic Package Plans
If selected as prime minister, he intends to compile an economic package to mitigate the impact of rising living costs and allocate funds for disaster relief. He emphasised that the package size should consider Japan’s “quite small” output gap, aiming to steer clear of deficit-covering debt issuance.
With the US dollar trading around the 168 yen level, comments from senior Japanese leadership signaling a reduced tolerance for a weak yen are a major alert. The focus on cost-push inflation suggests a political shift that could pave the way for a more hawkish Bank of Japan. We should therefore anticipate policies that favour a stronger yen to alleviate pressure on import costs and household budgets.
This view is supported by the latest inflation data, which showed Japan’s core CPI for August 2025 remained at 2.7%, stubbornly above the BOJ’s 2% target. This persistent inflation gives the central bank a clear reason to tighten policy further, especially now that it appears to have political backing. The era of prioritizing a weak yen for export competitiveness seems to be ending.
Given this, traders should consider positioning for a lower USD/JPY rate in the coming weeks. We see value in purchasing Japanese yen call options or establishing bearish risk reversals to capitalize on a potential strengthening of the yen. The policy divergence that has favoured the dollar is narrowing, as markets are now pricing in a greater than 50% chance of a US Federal Reserve rate cut before year-end while the BOJ is under pressure to hike.
Market Strategies
Implied volatility in USD/JPY options will likely rise as the market digests this potential policy pivot. This suggests that even before a clear direction is established, there are opportunities in buying option straddles to profit from the expected increase in price swings. We must be prepared for more direct verbal warnings from officials, which often precede official action.
We remember the direct currency interventions in 2024 when the yen weakened past the 160 mark, showing a clear line of discomfort for policymakers. The current rhetoric suggests that this line has not moved, and official action to strengthen the yen is a real possibility. Traders should reduce exposure to positions that rely on continued yen weakness.
