Yen softens after strong week, dollar steady as traders weigh rate outlook

By Ankur Banerjee

SINGAPORE, Feb 16 (Reuters) - The Japanese yen started the week on the back foot after strong gains last week on easing fiscal worries while the U.S. dollar was steady as soft inflation data boosted the case for interest rate cuts from the Federal Reserve later this year.

Liquidity is likely to be thin with markets in ?the U.S., China, Taiwan and South Korea closed for a holiday.

The yen ?eased 0.2% to 153.07 per U.S. dollar in early trading on Monday after climbing nearly 3% last week, its biggest weekly jump in about 15 months in the ?wake of Prime Minister Sanae Takaichi's landslide election victory.

"While many thought a supermajority for her LDP party would be ?negative for Japanese bonds and the yen, the exact opposite happened: They both rallied," ?said Brent Donnelly, a currency trader ?and founder of analytics firm Spectra Markets.

"The removal of uncertainty has encouraged long-term investors to dip their toes back in the water. With a bit of ?stability, those juicier Japanese yields are attracting plenty of interest. So ?are the Nikkei and the yen," he said. "It's called the 'Buy Japan' trade."

Data on Monday though laid bare some of the challenges facing Takaichi and her government with Japan's economy barely growing, eking out ?an annualised 0.2% expansion in the October-December quarter.

That may complicate ?the path for ?Bank of Japan tightening. The BOJ is due to meet in March with traders ascribing 20% odds for a rate hike.

And analysts expect the yen to soon return to a weakening trend.

OCBC maintained its 2026-end ?forecast for the yen to be at 149 per U.S. dollar. That reflects the view that the yen will ?struggle to transition from a funding currency to an investment currency unless the BOJ turns more hawkish than OCBC's current expectation of two rate hikes this year.

FED RATE CUT WAGERS

Data on Friday showed U.S. consumer prices increased less than expected in January, while at the same time suggesting little urgency for the Fed to resume cutting rates before June.

"The markets are flirting ?with pricing in ?a third cut," said Kyle Rodda, senior financial analyst at Capital.com.

Futures imply 62 basis ?points of additional easing priced for the rest of this year. The next cut is likely in June, with markets assigning ?68% odds to a reduction.

The euro traded little changed at $1.1863, while sterling eased slightly to $1.3638.

The dollar index, which measures the U.S. currency against six major peers, was steady at 96.959 after dropping 0.8% last week.

Much of the action after the inflation data was in the bond market. The U.S. two-year yield, which reflects interest rate expectations, closed at its lowest level since 2022 on Friday, while the 10-year yield fell 4.8 basis points. [US/]

Meanwhile, the Swiss franc was a touch softer at 0.7685 per U.S. dollar after gaining more than 1% last ?week, with investors increasingly wary of intervention from the Swiss National Bank to curb strength in the traditional safe haven.

"Further Swiss franc gains raise the risk of additional downside surprises relative to the SNB's inflation forecasts," said OCBC strategists in a note.

"This ?could potentially challenge the SNB's recent tolerance for currency ?appreciation, even if the bar for returning to negative rates remains high."

(Reporting by Ankur ?Banerjee in Singapore; Editing by Kevin Buckland)