BOJ Tightening Prospects Keep Yen Support in Play

Japan's Tankan report was released recently and it showed a reasonably positive picture of the economy, but not uniformly so. Large manufacturers saw their sentiment improve to 24 from 22, its strongest reading in years, while small manufacturers strengthened to 14 from 9.

The services side was less convincing, with large non-manufacturers slipping to 35 from 37 and small non-manufacturers holding at 15. Manufacturers also expect conditions to soften over the coming quarter, but other parts of the survey remain relatively firm, including employment conditions staying deeply negative at -38.

Price pressures also remain elevated, with input costs expected to fall to 55 next quarter, but output-price intentions suggest firms still expect to pass higher costs through to customers. Inflation expectations are above the BOJ's 2% target across one-, three- and five-year horizons, with the one-year outlook easing only slightly to 2.6%.

JPY OIS rates have eased from recent highs, particularly across the six-month to one-year tenors, suggesting traders are trimming expectations for the pace of future hikes rather than abandoning the prospect of further tightening altogether. This has implications for the yen, as further BOJ tightening should remain supportive at the margin.