• USD/JPY regains positive traction on Monday and climbs back closer to a nearly two-year peak.
• Economic risks due to the Middle East conflict counter intervention fears and undermine the JPY.
• The US-Japan rate differential further weighs on the JPY and supports the pair amid a bullish USD.

The USD/JPY pair attracts fresh buyers at the start of a new week and climbs back above mid-161.00s during the Asian session. Spot prices remain well within striking distance of the highest level since July 2024, touched last Thursday, and seem unaffected by speculation of imminent intervention by Japanese authorities.

In fact, Japan’s Finance Minister Satsuki Katayama reiterated on Monday that the officials are ready to respond appropriately to the currency moves at any time as needed. The Japanese Yen (JPY), however, continues with its relative underperformance in the wake of worries that Japan's economy will remain under strain due to the Middle East conflict and the continued energy supply disruptions through the Straight of Hormuz.

Iran announced that it had closed the strategic waterway again after accusing the US and Israel of violating the ceasefire. Iran added that the decision came over the continued Israeli strikes in Lebanon. Moreover, US President Donald Trump threatened fresh military action against Iran if Hezbollah continued attacks on Israel, underscoring the fragility of the diplomatic process and keeping the geopolitical risk premium in play.

This overshadows prospects for further  policy tightening by the Bank of Japan (BoJ), undermining the Japanese Yen (JPY) and supporting the USD/JPY pair. Minutes of the April BoJ meeting showed that some board members called ​for raising rates ‌more swiftly to avoid underlying inflation ​from overshooting. Moreover, BoJ Deputy Governor Himino said that the central bank will keep hiking rates based on economic, price, and financial trends.

Despite the BoJ's hawkish outlook, Japan's borrowing costs remain lower than those of peer nations like the US. The BoJ raised policy rates to 1.00%, or the highest since 1995, last Tuesday, while the US Federal Reserve (Fed) maintained its interest rate target range of 3.5% to 3.75% last Wednesday, which continues to fuel the JPY carry trade. This, along with the bullish sentiment surrounding the US Dollar (USD), supports the USD/JPY pair.

Traders ramped up their bets that the US central bank will deliver at least one 25-basis-point (bps) rate hike in 2026 following the Fed's hawkish forecast, signaling that it will need to raise the policy rate if inflation remains sticky. Moreover, geopolitical developments over the weekend assists the safe-haven USD to stall Friday's pullback from its highest level since May 2025, which turns out to be another factor pushing the USD/JPY pair higher.