FOREX-Yen firms as BOJ rate cut bets mount, sterling down on fiscal worries

By Gregor Stuart Hunter and Sara Rossi

SINGAPORE/LONDON, Sept 19 (Reuters) - The yen firmed against the dollar on Friday after the Bank of Japan's decision to hold rates steady came with two dissenting votes calling for a hike, while sterling fell after data showed Britain's borrowing surged past official forecasts.

The BOJ board dissent came as a surprise, unsettling equity and bond investors and putting their focus back on how soon the BOJ will next raise interest rates.

"This was unexpected, and suggests that perhaps policy rate hikes may be coming sooner than anticipated," said David Chao, global market strategist for Asia-Pacific at Invesco in Singapore.

The central bank's next meeting on October 30 will now be a live meeting, and "the best chance for a rate hike for the rest of this year," he added.

In a volatile session after the BOJ decision, which saw the board maintain interest rates at 0.5%, the yen surged initially but later pulled back, leaving the dollar down just 0.1% on the day at 147.8 yen JPY=EBS.

In a press conference following the decision, BOJ governor Kazuo Ueda said the bank would continue to raise interest rates if its economic and price forecasts prove correct.

In the meantime, Japan's ruling Liberal Democratic Party (LDP) holds a leadership race on October 4 to replace outgoing Prime Minister Shigeru Ishiba, with markets uncertain whether the outcome could impact the BOJ's policy path.

STERLING PRESSURE

Sterling was the worst performer among G10 currencies after Britain's borrowing surged past the official forecasts complicating the challenge for Britain finance minister Rachel Reeves's budget in November.

The currency fell as much as 0.5% to $1.3484 GBP=D3, heading for its biggest two-day drop since late July.

"Sterling is clearly on the backfoot. Despite a better reading from UK August retail sales data, poor UK government borrowing data have highlighted the difficulties Chancellor Reeves faces in delivering the UK budget in November," said Jane Foley, head FX strategist at Rabobank.

Data published early on Friday showed British retail sales rose by a stronger-than-expected 0.5% in August, helped by sunny weather, but sales growth in July was revised slightly down.

Across the broader currency market, traders are weighing the long-term economic impact on the dollar, the preeminent global reserve currency, from the Trump administration's barrage of tariffs and a wider shake-up in policymaking.

The market is ramping up bets on further easing, with pricing of Fed funds futures implying a 89.8% probability of another 25 basis point cut at the central bank's October meeting, up from 87.4% a day earlier, according to the CME Group's FedWatch tool.

Foreign demand for dollar-denominated fixed income assets remained healthy, with data from the Treasury Department showing overseas holdings of U.S. Treasuries rising to a record in July, surpassing previous highs for a third straight month, led by gains in holdings from Japan and the United Kingdom.

Elsewhere, the euro was 0.23% weaker at $1.1760 >. But it was set for a third successive weekly gain, up 0.3%, supported by expectations that the European Central Bank will leave interest rates unchanged over the coming months, compared with a likely decline in U.S. borrowing costs.