Tokyo’s Consumer Price Index (CPI) for August 2025 increased by 2.6% from the previous year, matching expectations but down from 2.9% in July. When excluding fresh food, the CPI rose by 2.5% year-on-year, also aligning with predictions and showing a decrease from the previous rate of 2.9%.
The CPI excluding fresh food and energy, a measure of core inflation, reached 3.1% on an annual basis, marking the highest rate since January 2024. Consumer inflation has surpassed the Bank of Japan’s 2% target for more than three years, alongside consistent increases in nominal wages.
Bank Of Japan Interest Rate Decisions
The Bank of Japan (BOJ) increased short-term interest rates to 0.5% in January. Governor Kazuo Ueda has urged caution in further rate hikes due to potential economic setbacks from US tariffs. BOJ monetary policy board member Nakagawa emphasised data-driven decisions, focusing on the upcoming Tankan report due by early October.
Other economic indicators showed Japan’s July industrial output fell by 1.6% month-on-month, while retail sales grew by 0.3% year-on-year. The unemployment rate dropped to 2.3%. In the US, potential interest rate cuts are on the horizon, with Stephen Miran’s hearing scheduled on September 4.
The policies of the Bank of Japan and the US Federal Reserve are clearly moving in opposite directions. The Fed is openly talking about cutting interest rates, while persistent inflation in Japan is keeping pressure on the BoJ to hike again. This growing divergence in monetary policy is the single most important theme for us to trade in the coming weeks.
Monetary Policy Divergence
In Japan, inflation remains stubbornly above the BoJ’s 2% target, especially the core measure excluding food and energy, which is at a high of 3.1%. We have seen consumer prices stay above the bank’s target for over three years, a key reason they finally raised rates to 0.5% back in January 2025. This environment supports the view that another rate hike is likely before the year is over.
However, there is reason for caution, as weak industrial output and retail sales figures show the economy has soft spots. BoJ board members are stressing they will be data-dependent, specifically pointing to the Tankan business survey due around October 1st as a key report. A surprisingly weak Tankan survey could easily push back the timing of the next rate hike.
Meanwhile, the message from the US is becoming much more straightforward, with Fed officials stating the time has come to lower rates. This policy pivot is justified, as US core PCE inflation has steadily declined from its 2024 highs and now sits around 2.4%, well within sight of the Fed’s target. Markets are now confidently pricing in at least two rate cuts from the Fed by early next year.
This policy split points toward a weaker US dollar relative to the Japanese yen. We should position for a lower USD/JPY exchange rate, using derivatives like options to manage the risk around key data releases. Buying JPY calls or USD puts gives us a way to profit from a strengthening yen while controlling our potential downside.
This view also extends to interest rate markets, where we can expect the gap between US and Japanese bond yields to narrow. The potential for falling US Treasury yields and rising Japanese Government Bond yields creates opportunities. We can use interest rate futures to trade this convergence.
