FOREX-Yen set for best January since 2018; dollar firm ahead of tariff deadline

Updates throughout with mid-morning European prices

By Rae Wee and Amanda Cooper

LONDON/SINGAPORE, Jan 31 (Reuters) - The yen was set for its best January performance since 2018 on Friday, driven by the expectation for Japanese interest rates to keep rising, while the Mexican peso and Canadian dollar held firm ahead of U.S. President Donald Trump's deadline on tariffs.

Trump has said he will impose 25% tariffs on imports from Mexico and Canada from Saturday if the two countries do not crack down on the flow of illegal migrants and the drug fentanyl into U.S. territory.

The loonie CAD= languished near a five-year low at C$1.4477 and was set for a weekly decline of close to 1%, while the Mexican peso MXN= was recovering from its steep fall from the previous session and last stood at 20.6643 per dollar, though it remained on track for its worst weekly performance since October with a 1.85% fall.

"If (Trump) wants to talk tough, he's got to act tough as well, and that starts with actually announcing something concrete tomorrow," said Tony Sycamore, a market analyst at IG.

In Japan, the yen JPY=EBS weakened on Friday and was last 0.34% lower at 154.84, after BOJ Governor Kazuo Ueda said the central bank must maintain loose monetary policy to ensure underlying inflation gradually accelerates toward its 2% target.

Still, the yen has climbed more than 0.7% for the week thus far and is set to gain 1.6% for the month, which would mark its best January performance in seven years.

The currency has drawn support from expectations of further BOJ rate hikes this year, with Deputy Governor Ryozo Himino saying on Thursday that the central bank would continue to raise interest rates if the economy and prices moved in line with the bank's forecasts.

Data on Friday showed core inflation in Tokyo hit 2.5% to mark the fastest annual pace in nearly a year.

This week has witnessed wild swings in markets, particularly in U.S. technology stocks, which have left investors on edge, particularly in light of Saturday's tariff deadline.

OPTIONS MARKET

Demand for protection against big moves in the Mexican peso and the Canadian dollar has spiked, according to the options market, but overall, the currency market reaction to Trump's latest threat has been fairly muted.

"The yen has had a relatively strong week, but we're not seeing that safe-haven reaction today, so that does probably tell us the market is a little bit more relaxed about it and the potential for what he might bring than it has been previously," City Index strategist Fiona Cincotta said.

The euro EUR=EBS dipped to session lows after data on Friday showed German regional inflation slowed more than expected in December. It was last down 0.24% at $1.0367.

The European Central Bank (ECB) cut interest rates on Thursday and policymakers left the door open for another cut in March, as concerns over lacklustre economic growth supersede worries about persistent inflation. 0#EURIRPR

The Federal Reserve, meanwhile, kept rates steady this week and Chair Jerome Powell said there would be no rush to cut them again, though he also implied there was still scope for easing with rates being "meaningfully" above neutral.

Fed funds futures imply around 45 basis points worth of easing for the rest of this year. 0#USDIRPR

The dollar rose 0.2% to 108.33 against a basket of currencies =USD but was on track for a slight monthly loss of 0.3%.

Data on Thursday showed U.S. economic growth slowed in the fourth quarter, though consumer spending increased at its fastest pace in nearly two years.

Sterling GBP=D3 was last down 0.1% at $1.2403, set for a 0.7% drop this month.

The pound faced immense pressure at the start of the month as investors heavily sold British government bonds in a move that reignited concerns about Britain's finances.

The Bank of England meets next week and economists expect a cut of 25 basis points to the base rate. 0#GBPIRPR

Elsewhere, the Australian dollar AUD=D3 rose 0.2% to $0.622 but was set for a weekly decline of 1.4%, its steepest in more than a month. The New Zealand dollar NZD=D3 rose 0.26% to $0.565, though was similarly on track to lose 1.3% for the week.