The Bank of Japan (BOJ) raised interest rates to a level unseen in 31 years on Tuesday, aiming to normalize monetary policy amid mounting inflation pressures.
The BOJ has upped its short-term policy rate from 0.75% to 1%, a level last observed in 1995. The decision was primarily motivated by the need to manage price pressures stemming from the energy crisis sparked by the war in Iran.
The central bank noted that the risk of Japan’s economy sharply deteriorating due to the Middle East conflict has lessened, thanks to government measures to mitigate high fuel costs and progress in securing alternative energy supplies.
However, the bank warned of potential inflation risks, noting that businesses were passing on rising oil costs at a “relatively fast pace,” which could lead to higher consumer prices. “Taking into account that medium- and long-term inflation expectations have also continued to increase, there is a risk of underlying inflation deviating above our price target,” the BOJ said.
The rate hike was approved in a 7-1 vote, with board member Toichiro Asada, a Prime Minister Sanae Takaichi appointee, dissenting due to concerns that the Middle East conflict poses a bigger threat to economic growth than inflation. Governor Kazuo Ueda did not participate because he was undergoing medical treatment.
On Tuesday, the central bank also said it will continue cutting government bond purchases by 200 billion yen each quarter, eventually reducing monthly purchases to 2 trillion yen from April 2027 and maintaining that level thereafter.
Japan Spends Billions on Yen Support
The yen’s weakness also strengthened the case for a rate hike. Earlier in May, Japan’s top foreign exchange official, Atsushi Mimura, said “extremely speculative” trading was driving the yen’s weakness, while Finance Minister Satsuki Katayama signaled that the time for “decisive action” was drawing closer, raising expectations of possible currency intervention.
Later that month, Japanese authorities spent 11.7 trillion yen ($73.5 billion) intervening in currency markets to prop up the yen. Still, the efforts had limited impact, with the currency remaining near the levels that triggered intervention. Data from Japan’s Finance Ministry confirmed officials likely entered the market multiple times during the low-liquidity Golden Week holiday period.
On April 30, the yen rebounded sharply from a nearly two-year low of 160.725 per USD to 155.50. The currency strengthened further to around 155 by May 6 before reversing course and resuming its slide.
Notably, in February, the Federal Reserve revealed it conducted a dollar-yen “rate check” at the request of the U.S. Treasury, signaling possible currency market intervention. The move came as the dollar strengthened toward ¥160 against the yen, and reports of the Fed seeking quotes for a large yen purchase briefly pushed the dollar lower.
At the time of writing, the yen was trading at 160.29 per dollar, while yields on 10-year Japanese government bonds rose 3 basis points to 2.647%.
Revival Of Yen Carry Trade
The yen carry trade, where investors borrow cheaply in yen and invest in higher-yielding currencies, is gaining momentum again, helped by relatively low global market volatility. Leveraged funds boosted their bets against the yen to more than 115,000 contracts in the week ended June 9, marking the largest bearish position since November 2017, according to CFTC data.
The jump in short yen positions indicates traders expect the currency to keep weakening, viewing the BOJ’s rate hikes as largely priced in and unlikely to provide significant support for the yen.
JPMorgan strategists also said markets have already largely “priced in” a potential BOJ rate hike and foreign-exchange intervention, limiting their impact, unlike two years ago when both measures caught investors by surprise, reported Bloomberg on Monday, citing an analyst note.
The BOJ’s rate hike comes during a pivotal week for central banks against the backdrop of the U.S.-Iran deal.
While the Federal Reserve is expected to leave rates unchanged on Wednesday, growing inflation worries among policymakers have led markets to increasingly bet that the Fed’s next move could be a rate hike rather than a cut.
Disclaimer: This content was partially produced with the help of AI tools and was reviewed and published by Benzinga editors.
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