Bank of Japan: 25 Basis Point Rate Hike

The Bank of Japan (BOJ) announced a 25 basis point rate hike, raising the target interest rate from 0.75% to 1.00%. The BOJ stated that it will pause tapering its bond purchases starting in April 2027, maintaining its monthly purchases of Japanese government bonds at approximately 2 trillion yen.

Previously, according to a survey by industry media, almost all BOJ observers expected policymakers to raise the benchmark interest rate by 25 basis points to 1% at the conclusion of Tuesday’s two-day meeting. The BOJ had previously stated that Governor Kazuo Ueda had recently been hospitalized for treatment of an infected liver cyst and would submit his opinions to the board in writing rather than participate in the vote in person.

This anticipated BOJ rate hike would be the first since December of last year, coinciding with policymakers addressing the upside risks to inflation from the Middle East conflict—despite the imminent signing of an agreement to end the war. Markets will be closely watching for clues about when the BOJ might intervene again, with traders worried that a weaker yen could prompt intervention in the foreign exchange market after the meeting. Will the unwinding of yen carry trades repeat itself?

It’s worth noting that when mentioning the Bank of Japan’s interest rate hikes, many people immediately think of the “global storm” triggered by the unwinding of yen carry trades in August 2024. At that time, the unwinding of yen carry trades caused severe fluctuations in global markets; the Nikkei 225 index plummeted by 12% in a single day, and US stocks also suffered a sharp decline.

However, this time, the “damage” of the Bank of Japan’s interest rate hike may not be so significant.

The primary reason is perhaps that the current global monetary policy environment is vastly different from two years ago. This time, the Bank of Japan’s interest rate hike is not a counter-trend move. In 2024, the Bank of Japan’s interest rate hike was actually within a global easing trend; the combination of the Bank of Japan’s rate hike and the Federal Reserve’s rate cuts—a “rising in the East and falling in the West” interest rate scenario—resulted in a sharp clash.

Now, however, interest rate hikes are a general trend in various countries. The Bank of Japan’s (BOJ) decision to raise interest rates merely aligns it with other central banks shifting towards tighter policies—including the European Central Bank, which just implemented its much-anticipated rate hike last Thursday. Even with the policy rate raised to 1%, Japan will still have one of the lowest interest rates among developed countries.

Furthermore, market participants had largely anticipated today’s BOJ rate hike, and in some ways, the BOJ’s action was even considered too slow by many, as evidenced by the sell-off in the yen and Japanese government bonds over the past few weeks.

Unlike past concerns about carry trade unwinding triggering yen surges, many investors are now more anxious about whether the rate hike will be able to stem the yen’s current depreciation. Despite record-breaking interventions by Japanese authorities to support the yen, it remains hovering near the key threshold of 160 yen to the dollar—a level the Japanese government previously intervened in the market to address.

For resource-importing countries like Japan, currency depreciation exacerbates inflationary pressures.

Foreign exchange market positioning data shows that speculators’ short positions in the yen have recently risen to a nine-year high, indicating that yen carry trades continue to heat up despite intervention risks and the possibility of a Bank of Japan interest rate hike.

Macro analyst Taro Kimura stated, “As other major central banks raise interest rates, interest rate differentials may once again become a major driver of yen weakness, as they did in 2022, thereby increasing upside risks to inflation.”

Has the Bank of Japan’s interest rate hike been too slow?

An interesting phenomenon is that more than a year after Japanese government bond yields finally became high enough to attract global fund managers back to the country’s bond market, many overseas investors are actually beginning to withdraw.

Institutions such as T. Rowe Price Group Inc., Schroders Group, and Brandywine Global Investment Management have recently reduced their investments in Japanese long-term government bonds, or are holding only small amounts of such bonds. Latest data shows that in April, overseas investors sold more Japanese ultra-long-term government bonds than they bought, the first time since 2024.

This shift reflects market concerns that even with the Bank of Japan’s expected rate hike on Tuesday, the pace of its monetary tightening may not be sufficient to curb inflation or stabilize markets. For many, the allure of this year’s multi-decade high yields on Japanese government bonds has been overshadowed by concerns about the Bank of Japan’s slow response and vulnerability to political pressure.

A recent research report from JPMorgan Chase also points out that a rate hike by the Bank of Japan is unlikely to trigger a significant yen rally, and its intervention effect may be limited.

JPMorgan notes that the market has already largely priced in the Bank of Japan’s subsequent rate hike path. For a hawkish surprise, the central bank would need to clearly indicate an accelerated pace of rate hikes, or even raise rates above the neutral rate, but this is unlikely. Meanwhile, if the central bank decides to slow or even suspend reductions in government bond purchases from April 2027, it could be interpreted as dovish by the market. Overall, the risk of the meeting’s outcome being interpreted as dovish is higher, potentially triggering yen selling pressure.

JPMorgan Chase emphasizes that the current environment is significantly different from that of the summer of 2024. At the time, both the Japanese Ministry of Finance’s intervention and the Bank of Japan’s interest rate hike were unexpected. Meanwhile, weak US employment data fueled expectations of a Federal Reserve rate cut, leading to a broad weakening of the dollar and ultimately triggering a large-scale liquidation of yen short positions, causing the dollar to fall by more than 20 yen against the yen. In contrast, this round of rate hikes and interventions had already been partially priced in by the market, and after strong US employment data, the market began to factor in expectations of a Fed rate hike, providing broad support for the dollar.