The yen weakens, the dollar rises above 160 against the yen, the Bank of Japan performs moderately, and the Fed is worried – The yen weakened further on Monday, with little relief after a middling signal from the Bank of Japan and growing expectations for higher U.S. interest rates in the longer term, pushing the currency closer to 1986 levels.

The pair – which is pegged to the amount of yen required to buy one US dollar – broke above the 160 level after experiencing what analysts called a “flash crash” on Friday. The yen remained weak even as Japanese markets were closed for the holidays.

The dollar rose 1% against the yen to a 34-year high of 160.20. Prices are now close to the highs reached in 1986, when the United States threatened to impose trade sanctions on Japan.

The yen fell after the Bank of Japan did not send any concrete signals on monetary policy and money market weakness at its meeting on Friday. While the Bank of Japan did raise its inflation outlook for the next few years, it also lowered its forecast for economic growth, raising questions about the extent to which it may tighten monetary policy this year.

The Bank of Japan raised interest rates for the first time in 17 years in March, citing rising inflation expectations due to sharp increases in wages this year. But the move provided temporary support for the yen.

The sharply weaker than expected forecast is a bellwether for Japan and raises more questions about the Bank of Japan's forecast of rising inflation. Data on Friday showed inflation in April was below the central bank's annual target rate of 2%.

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But aside from negative domestic signals, the biggest pressure on the yen is ongoing concerns about the wide gap between U.S. and Japanese interest rates.

U.S. data for March – the Fed's preferred inflation gauge – were warmer than expected, raising bets that the central bank will be eager to start cutting interest rates.

The surge after the PCE data was released also put pressure on the yen.

The Fed is widely expected to keep interest rates on hold and is expected to adopt a hawkish outlook. The central bank is expected to start cutting interest rates by September or the fourth quarter.

Intervention fears will do little to stem yen slide

The dollar-yen exchange rate has actually breached levels that traders believe would attract government intervention in currency markets. 155 was considered the threshold at which the government would allow the yen to depreciate, but this was not the case.

While Japanese officials continue to issue verbal warnings, the lack of action may indicate limited resources to fully stem yen weakness.

The depreciation of the yen is also beneficial to the Japanese economy, which relies heavily on exports.

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