Image © Leonid Andronov, Adobe Stock

The Japanese yen slumped on Wednesday, lifting GBP/JPY from 2024 lows, after an influential policymaker said its July rally and recent global market volatility could prevent the Bank of Japan from raising interest rates again.

GBP/JPY rallied more than two percent after Shunichi Uchida told local leaders in Hakodate that recent global market volatility and July's spectacular appreciation of the yen could keep the Bank of Japan from raising interest rates for a third time.

“Japan's economy is not in a situation where the Bank may fall behind the curve if it does not raise the policy interest rate at a certain pace,” the deputy governor said in part of his speech. “Therefore, the Bank will not raise its policy interest rate when financial and capital markets are unstable.”

The Bank of Japan raised its interest rate for the second time on July 31 and said it could be raised further if inflation and economic growth are in line with its forecasts in the months ahead.

Above: GBP/JPY shown at daily intervals with NIKKEI 225 index.

This conspired with the effects of past official intervention on July 11 and heightened risk aversion on global markets to drive a reversal of the carry trade that had weighed heavily on the yen previously.

GBP/JPY slumped more than 13% from peak to trough through July as yen-funded carry trades were unwound, and as the market priced in a series of additional rate rises from the Bank of Japan for later this year.

However, the yen’s appreciation in more recent days had been accompanied by deepening losses for global markets, which had seen the NIKKEI fall as much as 10% in a single day on Monday this week.

“Financial and capital markets have seen a rapid weakening of the U.S. dollar and a decline in stock prices worldwide, triggered by the growing concern over a slowdown in the U.S,” Uchida said. “As a result of the correction of the yen's depreciation, the upside risk to prices arising from higher import prices has decreased.”

Above: USD/JPY shown at daily intervals with NIKKEI 225 index.

It’s not just global market volatility making additional increases in Japanese interest rates less likely, however, as Uchida also flagged that the recovery of the yen has also been tempering the upside risks to inflation.

“The Bank of Japan is engaging in damage control. As criticism of its hawkish hike mounts,” said Elias Haddad, a senior global markets strategist at Brown Brothers Harriman. “The BOJ is now only expected to hike 15 bp over the next 12 months, down from 50 bp expected right after its hawkish hike.”

Uchida’s comments and the resulting losses for the yen may have brought an end to its spectacular recovery and positioned the currency for further declines that could lift pairs like USD/JPY and GBP/JPY up ahead.

This would be particularly likely if global markets stabilise, leading investors to re-engage in carry trades as they did on Wednesday when the likes of the Mexican peso and South African rand were outperforming.