Surprising no one, BOJ kept the overnight lending rate at 0.50%. However, it was Governor Fukui’s reluctance to commit to a rate hike in August that hurt the yen in overnight trade with USDJPY setting a new 5 year high for the pair as it sprinted towards 123.50. “We need to be more confident about the outlook for the economy and prices,'' Mr. Fukui said in the post announcement press conference noting that board members were “in absolute agreement that there are still many factors that need to be examined closely.” Governor Fukui’s hesitation on tightening monetary policy even in light of tonight’s news that Japan’s spending on services increased to a six month high, suggests that Japanese policy makers continue to be concerned about the health of consumer demand in the nation and will likely need to see several more months of positive spending figures before committing to additional rate increases.

Fukui commentary of course sparked fresh buying in USD/JPY from carry traders as it essentially assured yield seekers that the interest rate differential between the dollar and the yen will not compress anytime soon. In fact, given yesterday’s hotter than expected US PPI numbers and the possibility of stronger than expected inflation readings from today’s CPI report market sentiment towards US monetary policy may shift dramatically.

Up to now most traders believed that under the best of circumstances the Fed would simply remain stationary for the rest of the year and may even cut rates if US economic slowdown tipped over into negative growth. However, recent upside surprises in both ISM readings as well as a nice rebound in the Retail Sales figures have provided the foundation for a possible Fed rate hike should pricing pressures persist in US .The Fed message which has consistently emphasized the risk of inflation as the expense of growth may now be taken more seriously by the currency market especially if US long term bond yields continue to rise. In short, current economic conditions remain favorable to the carry and despite the fact that yen is woefully oversold it may lose more ground against the greenback unless higher bond yields trigger a massive sell off in US equities in which case risk aversion would most likely trump any yield considerations and USD/JPY would fall.

Boris Schlossberg is a Senior Currency Strategist at FXCM.