USD/JPY: the downed pilot is getting ready to take off again

The dollar fell against the yen by almost 0.3% on Monday night as the Japanese government announced the recovery of the economy to levels that preceded the COVID-19 pandemic.

During the last seven-day period, the Japanese yen jumped up by about 1% against its US counterpart, demonstrating the third consecutive weekly growth.

The rise in JPY was favored by the general weakness of the greenback. Recall that the dollar was under pressure after the release of less hot than expected US inflation data for July.

Amid a slowdown in price growth, expectations of a less aggressive rate hike by the Federal Reserve intensified. Now many economists predict that the central bank will raise the figure by 50 bps after rates were increased by 75 bps in June and July.

The USD/JPY pair was back in the red zone at the beginning of the new week. Its sharp fall to around 132.90 on Monday night contributed to the release of statistics on Japan's GDP for the second quarter.

In May-June, the world's third-largest economy was able to recover to pre-pandemic levels.

According to the data, Japan's GDP grew by 2.2% year on year, while it contracted by 0.5% in the previous quarter.

The recovery of the Japanese economy was due to a significant increase in consumer spending during the reporting period. The figure rose after the government eased pandemic restrictions in the country at the end of March.

Many cafes, restaurants and other service establishments reopened in April after months of lockdown, pushing private consumption up 1.1% in the second quarter.

Of course, the fact that the Japanese economy has finally managed to return to its pre-pandemic levels cannot but please the government, which has been moving towards this goal for so long.

Recall that America was able to restore its economy, which suffered from the consequences of COVID-19, a year ago, and most of Europe by the end of 2021.

A significant lag behind other countries forced the Bank of Japan this year to devote all its efforts not to the fight against inflation, like its colleagues, but to post-COVID rehabilitation.

Now that the mission has been accomplished, one would think that the Bank of Japan would wind down its ultra-loose monetary policy and go hawkish for once.

However, many analysts believe that Tokyo will continue to dovish strategy, which will further aggravate the yen's position. This year, the Japanese currency has slipped against the dollar by more than 10%.

"We expect Japan's GDP growth to continue in the third quarter, but will most likely start to slow down again later on," said Takeshi Minami, an economist at the Norinchukin Research Institute.

According to analysts at Bloomberg, the slowdown in the Japanese economy will happen earlier - already in the third quarter. The spike in new cases of COVID-19 in the country points to the risk of a slowdown in the pace of recovery.

Japan continues to report record high levels of coronavirus infections. More than 200,000 new cases are registered here every day.

A further increase in the incidence may force the government to once again resume restrictive measures. In this case, economic activity in the region risks falling again, which will be another strong blow to the yen.

Meanwhile, experts predict a drop in consumer demand in Japan, not only amid a possible lockdown, but also due to the low purchasing power of the population.

Although inflation in Japan remains relatively moderate, prices are rising much faster than wages. The continuation of this trend may lead to a serious decline in private consumption, which will also have a negative impact on the country's GDP.

Based on the existing risks, many analysts believe that the BOJ will not change its course in the foreseeable future. This is hinted at in the statement that Japanese Prime Minister Fumio Kishida made today.

On Monday, he instructed the Cabinet of Ministers to develop an additional package of measures to help households and companies, which should soften the blow from rising living costs.

According to preliminary information, the government plans to use about $35 billion remaining in state reserves for subsidies to the population, instead of starting to fight inflation by raising interest rates, as other countries do.

According to analysts, the news about the preservation of the Japanese government's budget support may serve as a strong driver for the USD/JPY pair in the short term.

The yen fell against the dollar on Kishida's comments this morning. At the time of writing, the yen was trading at 133.50.