The Japanese economic data continues to improve, and the possibility of further interest rate hikes by the Bank of Japan still exists. From a marginal perspective, due to the USD/JPY hovering above key technical support levels, this further increases its downside risk.

The hawkish expectations of the Bank of Japan are progressing smoothly

The Japanese economic data released on Friday were either in line with expectations or higher than expected. The inflation rate in the Japanese capital Tokyo unexpectedly increased significantly in January, rising by 3.4% compared to the same period last year, while the inflation rate in December last year was revised upwards to 3.1%.

After excluding fresh food prices, the core inflation rate increased by 2.5% compared to the same period last year, which is in line with expectations and higher than last month's 2.4%. After excluding energy prices, the so-called core index rose 1.9% year-on-year, once again meeting expectations and one tenth higher than the data in December.

Although the Bank of Japan closely monitors the core core index taking into account fluctuations in energy prices, its annual inflation target, measured by indicators excluding fresh food, is 2%. The report from Tokyo was released three weeks earlier than the national inflation data, providing a leading indicator for predicting inflation in the market.

As the Bank of Japan attempts to create a virtuous cycle where sustained wage pressures lead to sustained domestic inflationary pressures, news elsewhere is encouraging.

The unemployment rate has slightly decreased to 2.4%, 0.1 percentage points lower than November and market expectations. This is not a new development, but the labor market situation is still very tight, with 1.25 job vacancies for every unemployed person. This ratio remains the same as last month.

In other places, retail spending - the main component of household expenditure and the largest part of the economy - surged 3.7% year-on-year in December, easily exceeding the expected slight growth of 3.2%. Compared to the 2.8% growth rate in November, this is a strong acceleration.

The October interest rate hike has been fully digested, and the risk has tilted ahead of schedule

This data suggests that the Bank of Japan is expected to continue raising interest rates after last Friday's 25 basis point hike.

The swap market has fully digested the expectation of raising interest rates by another 25 basis points before October, indicating that the possibility of early interest rate hikes in the first half of this year is gradually increasing. This is a big assumption, but if external economic conditions continue, the Bank of Japan may raise interest rates earlier, especially if it sees signs of a significant increase in wages at the end of annual negotiations in March.

Vice Governor of the Bank of Japan, Ryo Shimino, stated in a speech on Thursday that if the economic situation matches the bank's forecast, there will be an intention to further raise interest rates.

He emphasized that it is "abnormal" for long-term real interest rates to be negative outside of economic shocks, especially when deflationary pressures ease.

Due to the lack of further Japanese data this week, the US calendar will guide the USD/JPY towards the end of the month.

Despite being hit by tariffs, the USD/JPY still rose