Japan’s Prime Minister Sanae Takaichi said it is too early to judge how the Middle East conflict could affect Japan’s economy. The government is watching public concern about higher petrol costs and reviewing possible responses. Measures to limit the impact are not expected to involve changes to the fiscal 2026 budget. The government is considering using reserves so petrol prices do not rise to levels households cannot tolerate, and said there are reserves available under the fiscal 2025 and 2026 budgets.

Yen Market Drivers

At the time of writing, USD/JPY was up 0.30% on the day at 158.35. The yen is among the world’s most traded currencies and its value is influenced by Japan’s economic performance, Bank of Japan (BoJ) policy, the gap between Japanese and US bond yields, and market risk sentiment. The BoJ has a currency control mandate and has sometimes intervened to weaken the yen, though it does so infrequently due to political concerns with major trading partners. Ultra-loose policy between 2013 and 2024 weakened the yen, while a gradual unwind in 2024 and rate cuts elsewhere have helped narrow the 10-year US–Japan yield gap. The yen is often treated as a safe-haven, tending to strengthen when markets are under stress. We see that uncertainty around the Middle East conflict is creating headwinds for Japan’s economy. The government’s immediate focus is on rising gasoline prices, which have climbed over 8% in the last quarter to an average of ¥192 per liter, putting pressure on households. This is a primary concern that will guide short-term policy decisions.

Implications For Volatility

The government intends to use existing reserve funds from the 2025 and 2026 budgets to manage any energy price shocks. This tells us not to expect any new, large-scale fiscal stimulus that could significantly alter the economic outlook. Therefore, the main driver for the Yen will continue to be monetary policy and external risk factors, not government spending. With the USD/JPY trading at a high of 158.35, the Yen is unusually weak for a period of global stress where it typically acts as a safe haven. This level is near the same points where we saw market intervention back in 2024, suggesting that the risk of the Bank of Japan stepping in is increasing. This tension between safe-haven status and interest rate differentials is creating a fragile situation. From a policy perspective, the Bank of Japan has been slowly unwinding its loose policy since 2024, with its key rate now at 0.25%. While the US Federal Reserve has also cut its rates to around 3.50%, the yield difference between the two nations remains significant, which continues to favour the dollar. This ongoing, though narrowing, gap explains the Yen’s persistent weakness despite the BoJ’s gradual tightening. This mix of geopolitical uncertainty, a hands-off fiscal approach, and a tense currency level points towards higher market volatility. For derivative traders, this suggests that strategies built around sharp price movements could be advantageous in the coming weeks. We should be prepared for a potential spike in volatility in the USD/JPY pair as these conflicting pressures play out. Create your live VT Markets account and start trading now.

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