• USD/JPY trades around 163.90 ahead of the Federal Reserve’s monetary policy decision.
• Markets expect the US central bank to leave interest rates unchanged this week before a possible rate hike in September.
• The Bank of Japan is also expected to keep interest rates unchanged while maintaining a hawkish policy stance.

USD/JPY trades around 163.90 on Tuesday at the time of writing, up 0.11% on the day, as investors remain cautious ahead of the Federal Reserve’s (Fed) monetary policy decision on Wednesday and the Bank of Japan’s (BoJ) policy announcement on Friday. The lack of immediate catalysts is keeping the pair in a wait-and-see mode as markets look for greater clarity on the outlook for both central banks.

The US Dollar (USD) trades without a clear direction ahead of the Fed meeting, while the US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, is edging slightly higher. According to the CME FedWatch tool, markets assign a roughly 62% chance that the Fed will keep interest rates unchanged within the 3.5%-3.75% range, while continuing to price in a strong chance of a rate hike at the September meeting.

Fed Chair Kevin Warsh indicated at the previous meeting that forward guidance was “not well-suited to the current policy environment,” suggesting that policymakers are unlikely to provide significant signals about the future path of interest rates. However, market participants will closely watch for any clues on how long US inflation is expected to remain above the central bank’s 2% target.

In Japan, attention is now turning to the Bank of Japan’s policy decision on Friday. Markets expect the central bank to leave its policy rate unchanged at 1%, while maintaining a hawkish tone on the monetary policy outlook, supported by inflation conditions that remain consistent with a gradual normalization of policy.

Against this backdrop, monetary policy divergence between the United States (US) and Japan remains the key focus for investors. Until both the Fed and the BoJ deliver their policy decisions, USD/JPY is likely to remain range-bound as traders refrain from taking aggressive positions ahead of these two major events.

Japan outlook softens as BoJ’s cautious hiking path meets elevated USD/JPY

Strategists at BNP Paribas expect Japan’s expansion to lose some momentum, projecting that “annual GDP growth [will] stand at 0.8% in 2026, down from 1.1% in 2025.” Against this softer growth backdrop, they note that the Bank of Japan has already begun normalising policy, having “initiated a cautious process of ‘adjustment in the degree of monetary accommodation’ in 2024, lifting the policy rate to 1.0% so far (previously negative) – the highest since 1995.” BNP Paribas anticipates that this gradual approach will continue, with “a 25pb hike about every four to five months until a 2.50% terminal rate in 2028.”

In the currency market, DBS observes that USD/JPY “remains high near 164,” but characterises the move as increasingly fatigued, saying the pair is “exhausted by Japan’s policymakers’ talk of supporting the currency through interventions, more gradual rate hikes, and using the GPIF to purchase Japanese assets.”