Dollar Rally and Pressure on Bank of Japan

By Leika Kihara and Makiko Yamazaki

TOKYO (Reuters) – A dollar rally triggered by Republican Donald Trump's victory in the U.S. presidential election could heighten pressure on the Bank of Japan to raise interest rates as soon as December to prevent the yen from sliding back toward three-decade lows.

Trump's victory unleashed sharp dollar gains as expectations of tax cuts and tariffs fueled optimism about economic growth while raising inflation worries.

The greenback's strength briefly pushed the yen to a three-month low of 154.71 on Thursday, down from a high of 140.62 in mid-September.

While a weak yen boosts exports, it increases fuel and food import costs, negatively impacting consumption.

Rising inflation was believed to be a factor in the massive voter swing against the ruling coalition in last month's general election.

Japan's top currency diplomat, Atsushi Mimura, warned against sharp yen falls, stating authorities were ready to act against "excessive" currency movements.

A major concern for policymakers would be a renewed plunge in the yen towards the three-decade low of 162 to the dollar hit in July. This scenario had prompted the BOJ to raise interest rates to 0.25% on July 31.

In July, the tumbling yen led to calls from ruling party lawmakers for the BOJ to hike rates or signal intentions to increase borrowing costs.

Prime Minister Shigeru Ishiba surprised markets on Oct. 2 by claiming the economy was unprepared for further rate hikes but later softened his stance, stating he would not intervene in BOJ policy.

"Politicians don't want a weak yen, so even those previously cautious about rate hikes could support them if yen falls accelerate," noted Tsuyoshi Ueno, senior economist at NLI Research Institute. "In this sense, the weak yen could push the BOJ towards steady rate hikes."

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The BOJ exited a decade-long radical stimulus in March, raising short-term interest rates to 0.25% in July, believing Japan was progressing towards sustainably achieving its 2% inflation target.

While many analysts expect the BOJ to hike rates again by March, opinions divide on whether an action would occur in December or be postponed until January or March for more data.

The BOJ kept rates steady last month but removed language focusing on external risks, leaving the door open for a near-term hike.

Renewed yen falls may heighten the BOJ's likelihood to act in December, given the currency's weakness pushes import costs higher, analysts say.

"The BOJ hasn't clearly stated so, but its July rate hike likely stemmed from concerns over excessive yen falls," said Shinichiro Kobayashi, principal economist at Mitsubishi UFJ Research and Consulting. "If the yen approaches 160 to the dollar again, the likelihood of a year-end rate hike will rise."

Tomoyuki Ota, chief economist at Mizuho Research & Technologies, also views 160-to-the-dollar as the threshold heightening the chance of a BOJ rate hike and possible government intervention.

In past attempts to combat yen falls, the government and BOJ worked collaboratively. In July, Japanese authorities intervened in the foreign exchange market, spending 5.53 trillion yen ($35.8 billion) to stabilize the yen from 38-year lows near 162 to the dollar. At that time, the BOJ hiked rates and affirmed its commitment to increase borrowing costs.

BOJ Governor Kazuo Ueda's hawkish indications of near-term rate hikes at last month's policy meeting pushed the dollar down towards 150 yen.

"There's no doubt that the market trend is towards a weaker yen. If yen falls accelerate, the chances of a December rate hike will grow," Ota from Mizuho Research stated. "The government and BOJ will likely respond swiftly, potentially through currency intervention."

($1 = 154.4400 yen)