On Tuesday morning, USD/JPY is licking its wounds after a sharp fall the previous day. The pair plunged by 1.3% yesterday due to an unexpected boost for the yen, stemming from hawkish comments by the BOJ Governor, Kazuo Ueda. However, many analysts recommend refraining from selling the pair at this stage. Let's figure out why.

JPY enjoys its moment in the sun

At the start of the new trading week, the Japanese currency exhibited its strongest rise against the US dollar in the last two months, surging to a weekly high of 145.91.

This jump was largely attributed to an interview of BOJ Governor Kazuo Ueda given to the Yomiuri newspaper last Saturday. The official hinted at a potential end of the ultra-loose monetary policy in Japan over the next few months.

Ueda stated that the abolition of negative interest rates is one of the possible scenarios, provided there is continued inflation growth and wage increases in the country. He also highlighted that by year-end, the Bank of Japan would have ample information to decide whether it can end its ultra-low rate era and transition towards normalizing its monetary stance.

"In essence, Ueda has outlined a conditional timeframe for Japan's first interest rate hike. It's no wonder traders, having long awaited a hint of a monetary pivot from the BOJ, seized this statement, sending the yen soaring across the board," commented analyst Chris Weston.

The recent statements from the BOJ head invigorated hawkish sentiments among investors, leading to a sharp rise in yields on 10-year Japanese bonds, reaching nearly a decade high of 0.715%.

This has once again sparked speculation that the BOJ might adjust its yield curve control mechanism or altogether abandon it in the foreseeable future.

The BOJ's next meeting is slated for September 22. Most analysts believe that the central bank will opt for caution, maintaining all current parameters of its monetary policy, including the YCC (Yield Curve Control) system, given the ongoing high uncertainty surrounding inflation.

"For the BOJ to make its initial hawkish moves, a primary condition voiced recently by Ueda must be met. The regulator needs to be convinced of steady and robust price growth," emphasized analyst Leika Kihara.

In July, Japan's inflation hit 3.1%, surpassing the BOJ's 2% target for the 16th consecutive month. This could seemingly be an argument in favor of policy normalization. However, central bank authorities believe the current price growth is mainly driven by supply factors, like import costs. The regulator wants more assurance that future inflation will be underpinned by demand, ensuring it remains above 2%.

The primary focus for the Bank of Japan right now isn't just inflation dynamics, but wage growth and its forecasts.

Japanese firms traditionally begin their annual wage negotiations with unions in March. But some insights will be available earlier, with the country's largest union, Rengo, announcing its wage hike goal for the next year in early December.

Some experts believe that a significant raise could trigger much-anticipated changes from the BOJ.

The BOJ's initial hawkish move is likely to be adjusting the target yield for 10-year bonds, which currently stands at 0%, followed by raising short-term rates from -0.1% to zero.

"We expect the BOJ to announce the end of negative interest rates by April 2024," forecasts Daiwa Securities analyst Mari Iwashita.

Rising expectations among traders about rate hikes in Japan should bolster the yen in the medium term. UBS projects that the Japanese currency might strengthen against the dollar to 142.

Yet, Swiss bank economists currently advise traders not to sell the USD/JPY pair, suggesting they instead focus on the yen's growth against the euro or pound. They believe the greenback remains a tough nut to crack, potentially outperforming the yen in the short run.

USD/JPY may resume its rally

"We don't recommend initiating new long positions on the yen against the dollar just yet, as the American currency may see renewed growth later this week, boosted by robust US macroeconomic data," UBS noted last Monday when the USD/JPY pair showed a sharp drop.

Experts believe that in the short term, risks for USD/JPY are tilted to the upside. The dollar might revisit its recent highs against the yen by Wednesday if the upcoming US inflation report indicates an accelerated price increase. In July, annual inflation in the US stood at 3.2%. Currently, economists are forecasting an August jump to 3.6%.

If these forecasts are met or if inflation showcases even stronger upward momentum, it will reignite speculations about further rate hikes in the US this year.

Intensified hawkish market expectations concerning the Federal Reserve's subsequent monetary policy might trigger another robust dollar rally ahead of the next FOMC meeting on September 20.

"The yen remains vulnerable against the US dollar, even in light of its recent surge. The upcoming FOMC and BOJ meetings next week might once again shift the fundamental landscape in favor of USD," stated Bloomberg analysts.

Experts believe that this month, the Federal Reserve will likely pause its rate hikes, signaling further tightening if the data released this week indicates that US inflation is not decelerating fast enough.

As for the Japanese regulator, Bloomberg anticipates that it will maintain its current stance in September and emphasize the need to stick to a dovish approach as long as the future inflation trajectory remains unclear.

Should the Fed and the BOJ indeed proceed with these anticipated actions next week, the USD/JPY pair might exhibit strong upside volatility. Given such developments, we cannot rule out the possibility of Tokyo issuing new threats of currency interventions.