Yen soars as markets test BOJ, stocks cheered by inflation retreat

By Dhara Ranasinghe

LONDON (Reuters) – World stocks scaled one-month peaks on Friday thanks to signs inflation is easing, while the yen jumped to seven-month peaks and Japanese bond yields breached a central bank target as investors challenged its commitment to loose monetary policy.

European shares opened higher and the broad STOXX 600 index touched its highest since April, while Asian-Pacific shares outside Japan hit a new seven-month high and was headed for a third consecutive week of gains.

U.S. stock futures pointed to a weaker open for Wall Street but sentiment generally was upbeat a day after data showed U.S. price pressures easing further.

It was Japan that grabbed the market spotlight as the yen shot up and benchmark 10-year government bond yields breached the BOJ’s 0.5% ceiling on speculation that its yield curve control policy could be revised, or even abandoned, as early as next week’s policy meeting.

A wave of emergency BOJ buying later reined the yield back in, but markets remained jumpy.

The yen strengthened to 128.11 per dollar — its highest since late May. It was last up 0.8% and has rallied 6% in little more than three weeks since the BOJ stunned markets by widening the band around its 10-year government bond (JGB) yield target.

A newspaper report flagging the possibility of more flexibility has redoubled bets on a coming shift out of ultra-easy policy that seeks to pin yields near zero. The BOJ said it will conduct additional outright bond purchases on Monday, a move that should keep yields in check.

“I think it’s too early for the BOJ to give up,” said Nomura chief Japan macro strategist Naka Matsuzawa. “It still has ammunition to defend the 0.5% yield cap.”

The BOJ will likely raise its inflation forecasts next week and debate whether further steps are needed, sources familiar with the bank’s thinking told Reuters.

INFLATION OPTIMISM

Beyond Japan, market sentiment was dominated by overnight U.S. December inflation data that landed more or less on consensus expectations. The annual pace of headline consumer price rises slowed to 6.5% in December from 7.1% in November.

Investors responded by down-shifting expectations for U.S. interest rates. A Federal Reserve hike of 25 basis points rather than 50 next month is now anticipated, with futures markets pricing in rate cuts later this year.

Against this backdrop, MSCI’s World Stock Index rallied to a one-month high and was set for its biggest weekly jump in two months.

“These latest U.S. (inflation) numbers support the view that the Fed is moving towards 25 bps rate hikes and that is offering consolation to the equity markets,” said Nordea Chief Analyst Jan von Gerich.

The dollar slipped broadly and U.S. Treasuries rallied.

The yield on the 10-year U.S. Treasury yield fell to 3.418%, its lowest since Dec 7.

The euro rallied to a nine-month high of $1.0868 per and the risk-sensitive Australian dollar rose to a roughly five-month high at $0.6994.

News that Britain’s economy unexpectedly eked out some modest growth in November supported sterling, which rallied 0.25% versus the dollar.

Oil extended gains overnight – helped, too, by optimism about China’s reopening – and Brent crude futures were last up around 0.4% $84.33. [O/R]

Elsewhere, South Korea’s central bank raised its policy interest rate by 25 basis points on Friday, as expected, and economists now think it might have reached the end of its hiking cycle.

(Reporting by Dhara Ranasinghe; additional reporting by Tom Westbrook in Singapore and Kevin Buckland in Tokyo; Editing by Kim Coghill)