24.07.202619:07 Forex Analysis & Reviews: USD/JPY. Japan's CPI Report Provides Limited Support for the Yen

USD/JPY tested the 164.00 level yesterday for the first time in nearly 40 years. More precisely, the pair last traded in this price area in November 1986. It is worth noting, however, that at that time USD/JPY was already in a well-established downtrend, as the global foreign exchange market was still adjusting to the consequences of the Plaza Accord. Before the agreement was signed, the U.S. dollar had been significantly overvalued, with the exchange rate reaching 240–250 yen per dollar.

On September 22, 1986, the United States, Japan, the United Kingdom, France, and the former West Germany coordinated efforts to correct the overvalued U.S. dollar, triggering a sharp appreciation of the yen. The pair's brief return to the 164.00 level in late autumn 1986 proved to be nothing more than a corrective rebound.

However, whereas the pair was in a sustained downtrend nearly four decades ago, the situation in 2026 is the exact opposite, with USD/JPY firmly entrenched in a strong uptrend. In the mid-1980s, coordinated foreign exchange intervention by the world's largest economies was the primary driver of price action. Today, by contrast, USD/JPY is driven mainly by the yield differential between the United States and Japan. U.S. Treasury yields continue to significantly exceed Japanese government bond yields, supporting demand for the U.S. dollar and maintaining investor interest in carry trade strategies.

Japan's inflation report, released today, only added to the pressure on the yen despite the acceleration in the headline inflation indicators.

According to the official data, Japan's core Consumer Price Index (excluding fresh food) rose by 1.6% year-on-year in June, following a 1.4% increase in May. Inflation accelerated for the first time in several months, but it remained below the Bank of Japan's 2% target for the fifth consecutive month.

At first glance, the return to faster inflation could strengthen the position of those advocating further monetary policy tightening. However, an important nuance should be considered. For the Bank of Japan, the acceleration in CPI itself is less important than the quality of that inflation—its underlying causes, sustainability, and ability to evolve into persistent inflationary pressure.

This is precisely where the report falls short, preventing USD/JPY sellers from taking advantage of the stronger headline figures.

First, inflation in Japan remains largely imported. The main driver of June's CPI acceleration was a change in the comparison base for energy prices following the expiration of several government subsidy programmes. In other words, the increase in inflation reflected a technical base effect rather than stronger domestic demand.

This distinction is crucial for the Bank of Japan. As noted above, policymakers focus less on the inflation rate itself and more on the underlying drivers and sustainability of inflation. Ultimately, the central bank's primary objective is not simply to combat elevated inflation readings but to overcome the entrenched deflationary mindset among Japanese businesses and consumers. To achieve this, the Bank of Japan must be confident that price growth is being driven by rising wages, stronger domestic demand, steadily increasing service prices, and well-anchored long-term inflation expectations.

Clearly, if prices are rising mainly because of a weaker yen, higher commodity prices, or other external factors, tighter monetary policy is unlikely to be an effective response. Higher interest rates will neither lower oil prices nor reduce imported cost pressures.

In this context, the weakness of underlying domestic inflation and the slowdown in services inflation deserve particular attention.

Specifically, the core-core CPI (which excludes both fresh food and energy and is regarded as the best measure of underlying domestic inflation) slowed to 1.7% year-on-year in June from 1.8% in May.

This piece of the puzzle significantly changes the overall picture, allowing the Bank of Japan to refrain from rushing into further monetary tightening. Viewed as a whole, the report presents a mixed picture: despite the acceleration in headline CPI, underlying domestic inflationary pressure continues to weaken. In other words, the inflation process has yet to show signs of becoming self-sustaining.

Particular attention should also be paid to the slowdown in services inflation, with the relevant sub-index easing to 1.2% year-on-year. Unlike goods inflation, which is highly sensitive to exchange rate movements and import costs, services inflation is directly linked to domestic demand and wage growth. Despite the substantial wage increases agreed during this year's Shunto (Japan's annual spring wage negotiations between employers and labour unions), companies remain reluctant to pass higher labour costs on to consumers. This suggests that the sustainable cycle of wage growth ? higher service prices ? stronger inflation expectations, which the Bank of Japan considers necessary to justify further interest rate increases, has not yet been firmly established.

Therefore, Japan's June inflation report cannot be regarded as hawkish. Despite the acceleration in headline CPI, the composition of price growth points primarily to external factors, while underlying domestic inflation remains insufficiently robust. As a result, USD/JPY sellers have once again been left without strong fundamental arguments. As long as the yield differential between the United States and Japan remains wide and the Bank of Japan maintains its cautious policy stance, USD/JPY is likely to remain well supported.

At the same time, traders should remember that the pair is trading at exceptionally elevated levels. Therefore, long positions are best considered only after corrective pullbacks. The nearest resistance level is located at 163.80, corresponding to the upper Bollinger Bands line on the daily (D1) chart.