GBP/JPY weakens after Takaichi defeat, removing impediment to interest rate hikes

• GBP/JPY sells off after Sanae Takaichi’s defeat in the second round of the Japanese ruling party’s leadership election.
• Takaichi had warned that if elected, she would restrict the BoJ from raising interest rates.
• Pound retreats after Bailey signals a steady return to a more normal rate environment.

GBP/JPY falls almost one and a half percentage points to trade at 191.50 on Friday after news that former Japanese defense minister Shigeru Ishiba defeated his opponent Sanae Takaichi to win the second round of the GBP leadership race. ruling party LDP. Ishiba won by 215 votes to Sanae Takaichi’s 194 votes.

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

The Yen’s immediate reaction was to strengthen across all its peers. The expectation of higher interest rates is positive for the currency as it reduces capital outflows into currencies that offer higher yields.

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

Meanwhile, the British pound remains in a weaker position after Bank of England (BoE) Governor Andrew Bailey said earlier in the week that he saw interest rates continuing their gradual decline. Lower interest rates are negative for the Pound as they reduce capital inflows.

“I think the path for interest rates will be downward, gradually, toward the ‘neutral’ rate,” Bailey said Tuesday. The neutral interest rate is the long-run equilibrium level, or the “ideal” level for interest rates in the economy.

His comments come after a close five-to-four vote at the BoE’s August meeting that backed a quarter-point reduction by the bank, lowering borrowing costs 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 boosted on Wednesday, however, after BoE policymaker Megan Greene was more hawkish than Bailey when she said a “cautious and sustained approach to monetary policy easing” “It’s appropriate.”

Greene added “I think the risks to activity are on the upside, which might suggest the long-term neutral rate is higher and, all else equal, our policy stance is not as restrictive as we had thought.” Greene was one of four in the MPC who voted to keep rates in place in August.