The Australian dollar weakened on Wednesday after softer-than-expected inflation data sharply reduced expectations of another near-term interest-rate increase, while the Japanese yen recovered modestly but remained close to its weakest level in four decades.

As of approximately 7:17 AM GMT, the Australian dollar traded near $0.6952 against the U.S. dollar, falling about 0.33% during the session.

The Japanese yen strengthened by approximately 0.18%, with the dollar retreating to around 163.53 yen after closing the previous session near 163.82 yen.

Despite Wednesdays recovery, the yen remained close to the 164-per-dollar level and its weakest point since 1986, keeping investors alert to the possibility of intervention by Japanese authorities.

Australian inflation misses forecasts

The Australian dollar came under selling pressure after official data showed that inflation increased more slowly than economists and the Reserve Bank of Australia had expected.

Australias consumer price index rose 0.6% during the second quarter, following a 1.4% increase in the first three months of the year.

Annual headline inflation eased slightly to 4.0%, from 4.1%.

More importantly for monetary policy, the trimmed mean measure of underlying inflation rose 0.8% during the quarter, below market expectations for a 0.9% increase.

The annual trimmed mean inflation rate reached 3.6%, below both the 3.7% market forecast and the Reserve Bank of Australias projection of 3.8%.

RBA rate expectations retreat

The softer inflation figures prompted investors to sharply reduce expectations that the Reserve Bank of Australia would raise interest rates again at its August meeting.

Markets priced the probability of an August increase at only around 3%, compared with approximately 21% before the inflation report.

Expectations of another rate increase before the end of the year also weakened, although markets continued to assign roughly a 50% probability to such a move.

The shift was reflected across Australian financial markets. Three-year government bond yields fell around 10 basis points to approximately 4.48%, while Australian shares advanced about 1%.

Lower interest-rate expectations generally weaken a currency by reducing the prospective returns available on assets denominated in that currency.

That explains why the Australian dollar declined even though inflation remained above the central banks target range.

Inflation remains too high

The report did not eliminate inflation concerns entirely.

Australias annual inflation rate remained elevated, services inflation accelerated to 4.0% from 3.7%, and rent inflation held at 3.6%.

The Reserve Bank has already raised its benchmark interest rate three times this year to 4.35%, reversing all the easing implemented during 2025.

However, the latest figures suggest policymakers may now have more time to assess the economic effect of those increases rather than immediately tightening policy again.

For June alone, consumer prices fell 0.1% from the previous month as fuel prices plunged nearly 11%.

That decline helped lower the annual inflation rate for the month to 3.8%, although renewed increases in global oil prices could complicate the inflation outlook in the coming months.

Yen finds temporary support

The Japanese yen moved in the opposite direction on Wednesday, strengthening modestly against the dollar.

USD/JPY declined about 0.18% to approximately 163.53, after trading between 163.28 and 163.88 during the session.

The improvement was limited, however, and the yen remained dangerously close to the 164 level and the 40-year low reached recently.

Japanese officials have repeatedly warned that they are prepared to respond to excessive currency movements, increasing nervousness among traders holding large positions against the yen.

The risk of intervention becomes more significant when the currency weakens rapidly rather than simply when it crosses a particular numerical level.

Japans policy dilemma

The yens underlying weakness continues to reflect the wide difference between interest rates in Japan and the United States.

U.S. Treasury yields remain substantially higher than Japanese yields, encouraging investors to borrow in yen and purchase higher-yielding dollar assets.

Concerns surrounding Japans fiscal policy have added further pressure.

Prime Minister Sanae Takaichis plans for tax cuts and greater government spending have raised questions about future debt issuance and the countrys already strained public finances.

At the same time, political resistance to tighter monetary policy has complicated efforts to provide lasting support for the yen.

Fed decision could reshape both currencies

The next major move for both currencies may be determined by the Federal Reserves policy announcement later on Wednesday.

Markets were pricing in roughly a 30% probability of a 25-basis-point rate increase, although most investors expected the central bank to leave rates unchanged.

A hawkish message from the Federal Reserve could strengthen the dollar and push USD/JPY toward or above 164, potentially increasing the likelihood of Japanese intervention.

It could also place additional pressure on the Australian dollar, particularly after Wednesdays inflation report weakened expectations of further Australian rate increases.

A less restrictive message, by contrast, could weaken the U.S. dollar and provide relief for both currencies.

For now, the Australian dollar is being pressured by a domestic decline in rate expectations, while the yens modest recovery reflects caution rather than a decisive improvement in Japans currency outlook.