The nationwide consumer price index (CPI) data released on the 24th for February showed that inflation in Japan slowed to 1.3% year-on-year for the first time since March 2022. The core indicator eased from 2.6% to 2.5% y/y, with the slowdown driven by subsidies from the Takaichi administration covering household electricity and gas bills.

Needless to say, these figures are already outdated following the outbreak of the Gulf war. On March 30, the Tokyo regional price index for March will be published, and it will most likely come in higher than February's levels.

Dubai crude oil (Asia) futures have risen to $140, significantly higher than WTI or Brent futures. Since 95.1% of Japan's crude oil imports come from the Middle East, and 94.6% pass through the Strait of Hormuz, the consequences could be catastrophic. Concerns about stagflation and declining corporate earnings have surged, making the fundamental weakness of the yen easy to explain.

As long as the market takes into account Takaichi's stance against rapid rate hikes, forecasts for further actions by the Bank of Japan remain stable. At the same time, it is already clear that government spending to curb gasoline price increases will rise, with the previously allocated £280 billion expected to be exhausted in less than a month. Wage negotiations between the government and labor unions suggest that average wage growth in 2026 will be roughly at last year's level. With inflation rising, real wage growth may even slow, reducing purchasing power and further worsening the economic outlook.

Given the high level of uncertainty, no positive news from Japan should be expected in the near term. Risks are skewed toward a deepening crisis, and the yen has little chance of recovery.

The net short position on the yen increased by $2.06 billion over the reporting week to -$5.33 billion. Positioning is becoming increasingly bearish, and the estimated price continues to rise steadily with no signs of slowing.

In the previous report, we suggested that the pullback from 160 following the Bank of Japan meeting would be shallow. Indeed, the yen failed to break below support at 157.00/70 and is once again targeting a test of the psychological level of 160. The rise is being constrained by the risk of a sharp increase in inflation, as Japan is highly vulnerable to energy supplies from Persian Gulf countries, and further inflation dynamics are directly tied to prospects for ending the war. As more factors suggest that the warring parties remain far from any agreement, we assume the probability of a Bank of Japan rate hike is increasing, which will limit further yen weakening. However, the threat of a sharp economic deterioration will likely dominate, pushing the yen toward the 161.96 high.