Foreign exchange trading reminder: Sterling is boosted by wage data, and the market focuses on the expected policy adjustment of the Bank of Japan

On Wednesday (January 18), the US dollar index fluctuated in a narrow range at the beginning of the Asian market, and is currently trading around 102.48. The market is waiting for data such as the Bank of Japan's interest rate decision and evening US retail sales in December. The US dollar index fluctuated in a narrow range on Tuesday and closed basically flat. The pound led the gains against the dollar on Tuesday, as data showed faster wage growth in the UK.

The yen stayed at a near seven-and-a-half-month high on Tuesday amid expectations of a possible policy adjustment by the Bank of Japan that could end "yield curve control" and herald a tighter monetary policy stance.

Over the past few weeks, that expectation has helped the yen, which has rallied nearly 5 per cent against the dollar since January 6, climb.

Meanwhile, sterling led gains against the dollar on Tuesday, hitting a five-week high, after data showed wage growth in the UK picking up again, and the Bank of England closely monitors the data as it measures the extent of interest rate hikes.

Sterling rose 0.81 per cent to $1.2285 against the dollar on Tuesday, having rallied to a five-week high of $1.2299, buoyed by data showing faster wage growth in the three months to November and a faster-than-expected 27,000 increase in employment.

The focus remains on the Bank of Japan, where speculation about adjusting or ending its policy of controlling the yield curve has grown as the market has pushed the yield on 10-year bonds past the 0.5 per cent limit set by the BoJ and the scale of the central bank's bond purchases to defend that limit is starting to look unsustainable.

After a two-day meeting, the Bank of Japan is expected to make key policy decisions on Wednesday.

"The market is anxiously waiting to see if the BoJ can do something about this," said Amo Sahota, executive director at KlarityFX, a foreign exchange consultancy. "If they do, then USD/JPY will move towards 126. But I think they will hold steady for now, give the same warning and wait for a while."

The dollar rallied to around 129.15 against the yen on Tuesday as part of the yen took early profits, but closed back at around 128.08. However, investors need to be wary of the market's recovery in expectations of the Bank of Japan staying put and maintaining neutral language.

Markets are expecting big swings at the end of the Bank of Japan meeting on Wednesday, with overnight implied volatility rising to a six-year high, according to foreign exchange options data.

Risk aversion also supported the yen as fears of a global recession picked up at the Davos economic forum.

The Swiss franc also strengthened modestly. The dollar fell 0.45% against the Swiss franc on Tuesday to close at 0.9210, close to its lowest closing price in nearly eight and a half months.

As China's GDP and other data performed better than expected, the Australian dollar and the New Zealand dollar rose slightly on Tuesday. The Australian dollar closed up 0.49% against the U.S. dollar on Tuesday at 0.6986, and the New Zealand dollar closed up 0.74% against the U.S. dollar on Tuesday at 0.6424.

The euro fell 0.3% to $1.0787 against the dollar on Tuesday after Bloomberg coverage that while the possibility of a 50 basis point hike in February remains, the prospect of a 25 basis point hike in March is gaining support.

The dollar index closed flat at 102.36 on Tuesday. It has fallen nearly 3 per cent since the end of the first trading week of the year, weighed down by US data showing a slowdown in the pace of consumer price rises. The data suggested that the Federal Reserve may continue to slow the pace of interest rate hikes.

"Inflation is moving in the right direction for the Fed, so a 25 basis point rate hike has been priced in," said Joe Perry, senior market analyst at FOREX.com and CityIndex. "The market has been on the sidelines since then, probably until the fall, when the market seems to think the Fed will cut rates."

Tuesday's data confirmed the slowdown in inflation. The New York Fed's Barometer of Business Activity in New York State fell to its lowest point since mid-2020 in January as orders plummeted and job growth stalled. The New York Fed's manufacturing activity index plummeted to minus 32.9 this month from minus 11.2 in December. Economists had predicted a negative reading of 9.0.

institutional perspective

Bank of America: The U.S. recession will be delayed until the middle of the year, and the Federal Reserve will slow down the pace of interest rate hikes

Bank of America is increasingly optimistic about the US economy in 2023. Bank of America economists believe that while the US economy is still expected to decline moderately, the recession is expected to be delayed by three months, starting in the middle of the year; the unemployment rate is expected to peak lower than previously expected, expected to reach a peak of around 5.1% in the first half of next year, about 0.4 percentage points lower than previously forecast. In addition, Bank of America still expects the federal funds rate range to be 5% -5.25%, but has delayed the expected time to reach that level. The Federal Reserve is expected to raise interest rates by 25 basis points at its meetings in February, March and May, before switching to rate cuts and shrinking its balance sheet in March next year. The bank had expected the Fed to raise interest rates by 50 basis points at its February meeting.

ECB considers slowing rate hikes after 50 basis points in February

ECB policymakers are starting to consider raising interest rates at a slower pace than President Christine Lagarde indicated in December, according to officials familiar with the discussions. The prospect of a modest 25 basis point hike at the March meeting is gaining support, the officials said, despite Lagarde's hint that a 50 basis point hike in February is still possible. The officials said the slowdown in the pace of monetary policy tightening at the ECB should not be seen as a softening of its functions. They stressed that no decision had been made and that policymakers could still announce a 50 basis point hike at the March meeting.

Institutional analysis: Canadian inflation slows to 6.3%, opening the door for a pause in rate hikes

Canada's headline inflation and the Bank of Canada's preferred measure of potential stress both slowed, suggesting the central bank may soon stop sharply raising interest rates. Tuesday's CPI report showed that the rapid rate hikes of the past 10 months have begun to dampen price rises, although inflation remains well above the central bank's 2 per cent target. The data support the view that the central bank's most aggressive tightening cycle is coming to an end, with the Bank of Canada expected to raise rates by 25 basis points next week before pausing.

Commonwealth Bank of Australia: The Bank of Japan may let the dollar rise to up to 5 yen against the yen

Kristina Clifton, senior currency strategist at the Commonwealth Bank of Australia, said the BoJ's policy decision today could lead to significant volatility in currency markets amid speculation that the BoJ could change its stance further. If the BoJ takes a dovish stance, the dollar could rise as much as Y2-5 against the yen. If markets interpret any policy correction as a step towards normalisation, the pair could "fall significantly". "We see little risk that the BoJ will again widen or abandon its target for the 10-year JGB trading band," Mr. Clifton said.