GBP/JPY weakens after Takaichi defeat removes impediment to rate hikes

• GBP/JPY sells off following the defeat of Sanae Takaichi in the Japanese ruling party’s leadership run off. 
• Takaichi had warned that if elected she would restrict the BoJ from raising interest rates. 
• The Pound pulls back after Bailey indicates steady return to more normal rate environment. 

GBP/JPY declines by almost one and a half percentage points to trade in the 191.50s on Friday after the news that former Japanese defense minister Shigeru Ishiba beat his opponent Sanae Takaichi to win the ruling-LDP party’s leadership race run-off. Ishiba won by 215 votes to Sanae Takaichi’s 194 votes. 

The Japanese Yen had weakened on concerns Takaichi might win after she said that if elected she would not allow the interest rates to rise because a weak Yen was positive for exports. Her defeat now means she will not be able to restrict rate hikes. 

The Yen’s immediate reaction was to strengthen in all its pairs. The expectation of higher interest rates is positive for the currency since it reduces capital outflows to currencies offering higher returns. 

GBP/JPY came under further pressure after the Japanese Yen rose following the release of Tokyo inflation data early on Friday. The data showed the Tokyo Consumer Price Index (CPI) rose 2.2% in September, which whilst lower than the 2.6% previously, was in line with the BoJ’s forecast and the median. BoJ Governor Kazuo Ueda had said that if inflation data met the bank’s forecasts it would go ahead with plans to lift interest rates. 

The Pound Sterling, meanwhile, remains on a weaker footing after the Governor of the Bank of England (BoE) Andrew Bailey said earlier in the week that he saw interest rates continuing to fall gradually. Lower interest rates are negative for the Pound as they reduce capital inflows. 

“I do think the path for interest rates will be downwards, gradually, to the ´neutral’ rate,” Bailey said on Tuesday. The neutral rate of interest is the long run equilibrium level, or “ideal” level for interest rates in the economy. 

His remarks come after a close call five-to-four vote at the BoE’s August meeting backed up a quarter point cut from the bank, pushing borrowing costs down to 5.00%. Financial markets, meanwhile, are pricing in a drop to 4.5% by the end of 2024, and lower to 3.5% by the end of 2025.

GBP/JPY was buoyed on Wednesday, however, after BoE policymaker Megan Greene was more hawkish than Bailey when she said that a “cautious, steady-as-she-goes approach to monetary policy easing is appropriate.”

Greene added “I believe the risks to activity are to the upside, which could suggest that the long-run neutral rate is higher and - all else equal - our stance of policy isn’t as restrictive as we had thought.”  Greene was one of four on the MPC who voted to hold rates in August.