Inflation expectations hit a 21-year high, risks of yen depreciation continue to accumulate.

Given the bets on inflation rising in the Japanese market, the post-inflation-adjusted government bond yields are being suppressed, thereby weakening their support for the yen. A key indicator of market expectations for future price increases, the 10-year breakeven inflation rate, soared to its highest level since 2004 this week. Although Bank of Japan Governor Haruhiko Kuroda recently strongly hinted that the central bank may tighten monetary policy to curb inflation at its meeting later this month, the indicator touched a high of about 1.74% early Monday and has since been maintained at above 1.7%. If the Bank of Japan raises policy rates, nominal government bond yields are likely to rise, which is usually positive for the yen. However, if consumer prices continue to rise significantly, the purchasing power of the yen will be eroded, and the boost from this action will be greatly diminished. The yen has fallen over 4.5% against the US dollar this quarter, with the USD/JPY rate at 155.51 at the time of writing. "With inflation expectations heating up, the Bank of Japan's rate hike measures will not lead to an actual increase in real interest rates, making it difficult to support the yen," said Makoto Noji, Chief Forex and Foreign Bond Strategist at SMBC Nikko Securities. The 10-year breakeven inflation rate reflects the difference between nominal government bond yields and yields on inflation-linked bonds of the same maturity. Currently, after subtracting the breakeven inflation rate from the 10-year government bond yield, the real yield is only about 0.2%. Kuroda has stated that current real interest rates are low and that even with future rate hikes, monetary policy will remain accommodative.