Japanese yen struggles as big spending LDP wins decisive victory
Currencies globally took last week’s volatility in equity and cryptocurrency markets relatively in stride.
Highlights:
Japan’s PM Takaichi wins big at weekend’s election.
Yen holds its own, but more downside possible.
Pound struggles on Starmer woes, dovish BoE.
ECB stands pat, hints at no change for foreseeable.
RBA hikes rates amid fears over rising inflation.
Delayed US payrolls report to be released on Wednesday.
All G10 currencies ended the week within 1% of their starting points, with the conspicuous exception of the yen. The Japanese currency sold off aggressively through the week and continued to fall in early Asian trading as markets came to grips with a two-thirds LDP supermajority in parliament, which assures that the fiscal spigots will be turned wide open. The pound also suffered from the Bank of England’s apparent dovish turn. The week’s winners were Latin American currencies, most of which ended up beating every G10 currency except the Australian dollar and remain top performers so far in 2026.
The delay in critical US data, caused by yet another partial shutdown, postponed the key January labour report until Wednesday. Together with the January CPI inflation report, which is delayed until Friday, these key indicators will be the focus of the week and will certainly create a volatile trading environment – they are usually never released in the same week. The other major factor in currency markets will be the bond market’s reaction to the LDP’s smashing victory in the Japanese elections and the prospect of fresh budget deficits, which will certainly test the fragile balance reached recently in Japanese bond markets.
USD
The dollar has stabilised after a rocky start to the year, as tariffs and institutional degradation continue to make hedging dollar risks the path of least resistance for foreign asset managers. However, economic data has been holding up well and markets have taken in stride the appointment of Trump’s political ally Warsh to replace Powell, who we continue to see as probably the least bad option to take over as FOMC chief.
Recent volatility and churn in equity and crypto markets have had little impact on currency and bond markets. This calm will be tested this week by a trifecta of high stakes economic releases that seldom coincide: retail sales on Tuesday, the January labour market report on Wednesday, and January inflation to cap the week on Friday.
EUR
The euro received modest support last week due to the absence of serious ECB pushback against and concern about currency appreciation. The meeting was otherwise uneventful, with the ECB sticking to script and offered little forward guidance. Lagarde stressed that policy remains in a “good place” and that risks to both inflation and growth were broadly balanced. While she noted that the bank was monitoring the euro exchange rate, she also played down the recent appreciation.
The January flash inflation report for the Eurozone came out lower than expected, confirming that the ECB is the first major central bank in the G10 to return inflation to its target. This provides the institution further assurance that it can sit on its hands for some time and wait for developments to unfold. Markets now see a greater chance that the next move is another cut than a hike, but swaps are still pricing in no change in policy throughout the rest of 2026.
GBP
Fears about the future of Keir Starmer’s leadership returned last week due to fallout from the Epstein scandal. Combined with the Bank of England’s apparent dovish turn, this made for a rough week for sterling. We expect that the MPC’s dovish rhetoric will affect the timing of cuts more than their total size, and the terminal rate will see little change. It now appears to be a coin-toss between the March and April meetings, with a total of two rate reductions largely priced in by swap markets. The tone from economic releases has also taken a positive turn over the last few weeks.
Overall, we think the recent drop in the pound fairly reflects the risks associated with an end to Starmer’s leadership. However, the risk of a leftist turn in the government, particularly under an Angela Rayner led Labour Party, presents downside risks to the pound and British assets generally.