Why we’re raising our USD/JPY forecasts

Sanae Takaichi’s victory in the recent ruling LDP leadership election has had a significant impact on Japanese asset markets. She's set to be Japan's first female Prime Minister, and the view is that her leadership aims to recreate the reflationary set of policies introduced by Shinzo Abe after his election in late 2012. Those policies were most famously associated with a steeper yield curve, a weaker yen, and a stronger stock market. And that has been the initial reaction in markets this month.

But Japan in 2025 is quite different to Japan in 2013. Back then, a new BoJ Governor introduced a 2% inflation target to a nation mired in deflation. The introduction of Quantitative and Qualitative monetary easing (QQE) saw the BoJ grow its balance sheet from 30% to 100% of GDP over the next seven years as it flooded the market with liquidity.

Today, the BoJ is in the process of monetary normalisation at a time when CPI has not been below 2.0% since the summer of 2022. And high inflation and the cost-of-living crisis topped voters’ concerns in Upper House elections this July. Higher inflation surely cannot be on top of the new government’s wish list.

We doubt, therefore, that current expectations of the BoJ tightening cycle – looking for a 100bp rate hike over the three to four years – gets crudely swapped for an easing cycle. Yet the political headwinds to rate hikes have grown and will limit the yen’s scope to appreciate on a multi-year view. We now think USD/JPY will end 2025 and 2026 closer to 148 and 142, respectively, and are still looking for the weaker dollar trend to dominate.

Developments in Japan, some softer confidence data in Europe, French political risk, plus ongoing strength in the US consumer, mean that the dollar bear trend has stalled. Even the idea of a mass exodus from the greenback in the second quarter is being reassessed after IMF data showed a broadly unchanged share of the dollar in central bank FX reserve portfolios.

Yet our baseline view of a further 100bp easing in the Fed policy rate remains intact, easing which will lower dollar hedging costs and should carry the dollar a little weaker into 2026. At the same time, the thesis of a captured Fed is still present, and the dollar typically weakens in November and December. 1.20 still looks like the direction of travel for EUR/USD this year.