The Japanese yen strengthened broadly in Asian trading on Friday against a basket of major and minor currencies, extending gains for a second consecutive session against the US dollar after the Japanese government signaled plans to encourage pension funds to increase their holdings of domestic financial assets.

Government data released in Tokyo also showed producer prices rose to their highest level in three years in June, the latest sign of renewed inflationary pressures facing Bank of Japan policymakers, reinforcing expectations of another interest rate hike in October.

The Price

The US dollar fell 0.65% against the yen to 161.29, from Friday's opening level of 162.35, after reaching an intraday high of 162.42.

The yen ended Thursday's session up 0.15% against the dollar, marking its first daily gain in five sessions as it continued to recover from its weakest levels in 40 years.

In addition to bargain buying, the yen also benefited from easing military tensions between the United States and Iran.

Japanese government and pension funds

Japanese Finance Minister Satsuki Katayama said on Friday that the government will explore ways to encourage pension funds, including the Government Pension Investment Fund (GPIF), to increase their investments in domestic financial assets.

Market views and analysis

Fabian Yeap, market analyst at IG, said: "Pension funds are enormous in size, so you can imagine the impact if there is a structural shift in how they allocate their assets."

Yeap added: "At the moment, around 50% of their portfolios are allocated to foreign assets. Any change in that allocation would certainly generate larger flows into domestic assets. That would support the yen while also benefiting Japanese equities and bonds."

He also noted: "With the yen trading near its weakest levels in almost 40 years against the dollar and policymakers having limited options to support the currency, addressing the issue structurally by encouraging greater investment in yen-denominated assets would provide stronger and more sustainable long-term support for the currency."

Japanese government and central bank

Economy Minister Minoru Kiuchi said on Friday that the government will not interfere with the Bank of Japan's decisions on interest rates, emphasizing that monetary policy remains solely the responsibility of the central bank.

Kiuchi added that the government is revising the wording of the monetary policy section in its annual economic plan to avoid any interpretation that it is exerting political pressure on the central bank. The revised plan is expected to receive formal government approval next week.

Japan producer prices

Data released in Tokyo showed that Japan's producer price index rose 7.1% year on year in June, the fastest increase since March 2023, exceeding market expectations of a 6.8% rise and accelerating from a 6.6% increase in May.

Japanese companies have increasingly passed on the higher costs resulting from the conflict in the Middle East to consumers, strengthening expectations that the Bank of Japan could raise interest rates once more before the end of the year.

The data followed a Bank of Japan report released on Thursday warning that the pass-through of higher input costs is accelerating and could push consumer inflation higher later this year.

Japanese interest rates

Markets continue to price the probability of a 25-basis-point Bank of Japan rate hike at the July meeting at below 25%.

The probability of a 25-basis-point rate hike at the October meeting has climbed to above 75%.

Investors are awaiting additional data on inflation, unemployment, and wage growth in Japan to reassess those expectations.