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The dollar faced strong pressure across the currency market at the beginning of the week, and only the Japanese yen failed to capitalize on the favorable conditions, as it also declined due to domestic factors.
Prime Minister Takaichi on Monday announced early elections and promised to introduce several measures to ease fiscal policy. The biggest blow was dealt to long-term Japanese government bonds, with the yield on 20-year Japanese government bonds reaching its highest level since 1997 on January 20, while the yields on 30-year and 40-year bonds soared to record highs.
The yen fell to record lows against the euro and the Swiss franc.
The consequences of Takaichi's decisions are difficult to qualify as anything other than shocking. The decision to dissolve the lower house of Parliament is obviously tied to Takaichi's confidence that she will win in the new elections. Control over Parliament is necessary to expedite the planned steps to change fiscal policy, particularly the intention to exempt food from the consumption tax for two years. The consequences of such a step will be massive—annual tax revenues will decrease by about 5 trillion yen, which significantly exceeds the effects of canceling "temporary" gasoline and diesel fuel taxes (around 1.5 trillion yen) or increasing the minimum taxable annual income. This is one of the reasons for the collapse of the bond market; the loss of such a significant revenue influx to the budget will necessitate even larger borrowings and a subsequent increase in public debt.
For controlling inflation, this step is positive; it will lead to slower price growth, and for households, it means reduced expenditures, which is also positive. A 0.4% increase in GDP is also expected in the first year.
The Bank of Japan is set to announce its monetary policy decision on Friday, but after raising interest rates at its January meeting, no changes are expected.
Instead, the focus will be on communicating the scale and pace of further monetary policy tightening, with a hard stance likely as a weak yen and political uncertainty increase inflation risks.
Speculative investors actively sold yen futures, with a weekly change of -4.3 billion; for the first time in many months, a net short position on the yen formed at 3.6 billion.
A week earlier, we saw a good opportunity for the yen to start strengthening; however, the "Takaichi factor" turned everything upside down. Markets assume that the measures outlined by the Prime Minister not only increase the hole in the budget, which equates to actions aimed at lowering the yen's value, but also exert potential pressure on inflation, and therefore on forecasts for further rate hikes. In essence, the market now needs to revise its rate forecasts.
Until the results of the elections on February 8, the yen will likely not be able to start strengthening even amidst a weak dollar. The most likely scenario is a slow drift towards a maximum of 161.96 in anticipation of new inputs. Objectively, neither the Cabinet nor the Bank of Japan is interested in further weakening of the yen, but they will be forced to wait for the election results and the implementation of fiscal stimulus.
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