FOREX-Yen slips ahead of Japan election, intervention fears linger

By Stefano Rebaudo and Ankur Banerjee

Jan 15 (Reuters) - The yen edged lower on Thursday as traders fretted over the impact of possible increased fiscal spending, while keeping a close watch for any signs of Bank of Japan intervention to shore up the currency near the 160 level.

Japan's Prime Minister Sanae Takaichi plans to dissolve parliament's lower house next week to capitalise on a surge in public support for a new leader who has promised to spur economic growth, tackle cost-of-living concerns and tighten immigration rules.

The prospect of an early election has triggered fiscal concerns amid worries about the country's massive debt load, dragging the yen down and complicating the rate path for the Bank of Japan.

However, this year, conditions may be more favourable to increase fiscal spending.

"In 2026, she (prime minister Takaichi) is likely to benefit from a favourable base effect in consumer price index, as lower rice prices will drive headline inflation to moderate towards 2%," said Claire Huang, senior emerging markets macro strategist at Amundi Investment Institute.

"This benign inflation environment should buy Takaichi valuable time to advance her economic expansionism agenda."

The yen JPY= was down 0.15% at 158.69 per dollar after firming 0.4% on Wednesday as Japanese Finance Minister Satsuki Katayama renewed a verbal warning on "one-sided depreciation". U.S. Treasury Secretary Scott Bessent urged policy measures to address FX volatility.

The currency though was not far off the 18-month low of 159.45 it touched on Wednesday and has dropped nearly 5% since Japan's Prime Minister Sanae Takaichi took office in October.

"Risks are heavily skewed to the downside for the dollar/yen in 2026,” said Stephen Jen, CEO at Eurizon SLJ Capital, mentioning the divergence in policy rate outlook between Japan and the U.S.

“Interventions at the right moment could trigger such a correction,” he added, after arguing that with the yen at 160 against the dollar, the risks are high for the Ministry of Finance to step in.

Japan last intervened in the currency market in July 2024, spending $36.8 billion to lift the currency as it fell to a 38-year low of around 161.96 to the dollar.

Prashant Newnaha, senior Asia-Pacific rates strategist at TD Securities, said if the yen continues to weaken towards or within intervention threshold ranges, then intervention risk cannot be ruled out this coming Monday, a U.S. holiday, at 161-163.

The BOJ is due to meet next week with markets broadly expecting the central bank to stand pat after it raised rates last month to a 30-year high of 0.75%.

FED INDEPENDENCE UNDER THE SPOTLIGHT

The dollar was knocked back on Monday after the Federal Reserve Chair Jerome Powell called out the subpoena from the administration of President Donald Trump, saying it amounted to intimidating the Fed into delivering easier monetary policy, but it recovered its losses the day after.

Benoit Anne, managing director at MFS Investment Management, said the latest episode reinforces the case for global diversification.

However, some analysts argued there was a reasonable chance the dollar would ultimately emerge stronger from this episode.

"Powell could be viewed as more resolutely hawkish in an effort to reinforce Fed independence," said Francesco Pesole, forex strategist at ING.

Traders took the escalation in stride even though investors remain concerned about the Fed's independence under Trump.

Against a basket of currencies, the dollar =USD was up 0.14% at 99.199, not far from a one-month high it touched last Friday at 99.268, before the subpoena was issued to Powell.

The euro EUR= dropped 0.12% to $1.1630.

Trump said on Wednesday he has no plans to fire Powell despite the Justice Department's criminal investigation into the Fed chair, but it was "too early" to say what he would ultimately do.

Recent economic data has cemented the case for the Fed to stay on hold in January with markets still expecting two rate cuts this year but not before Powell's term ends in May.