The US Federal Reserve's first interest-rate increase since 2023 and its signal of an additional hike later this year turn the spotlight on other central banks, including the Bank of Japan, which is set to review monetary policies. According to latest reports, a BOJ hike is all but certain amid pressure from U.S. Treasury Secretary Scott Bessent, while a Fed hike remains possible given concerns over a prolonged Middle East war and surging international oil prices. The convergence of these decisions is drawing global attention to monetary policy developments, with the BOJ potentially bringing the unwinding of yen carry trades back into focus after its 0.25 percentage point increase in June. Latest market data shows markets assigning a 97 percent probability to a 25bp hike at the September 18 meeting, with USD/JPY breaking below the key 155.00 level and triggering further dollar selling. Japan's Nikkei was largely flat on Wednesday as investors remained cautious ahead of interest-rate decisions, with weakness in chip stocks offsetting gains in energy and trading shares, while the broader Topix outperformed.
The yen got off to a weak start against the dollar and the euro at the start of Asian trading on Friday, with currency markets in a subdued mood ahead of an expected rate hike from the Bank of Japan later in the trading session. According to CNBC TV18, the yen fell 0.1% to 156.19 yen per dollar, resuming its decline after snapping a three-day losing streak on Thursday as traders prepare for the Japanese central bank to lift interest rates to the highest level in more than three decades. Against the euro, the yen was 0.2% weaker at 179.3000 yen. The yen's softness followed data released Friday which showed Japanese inflation fell slightly short of expectations in August. Swaps pricing indicates that the market views a hike from the BOJ as 83% likely, with quarterly rate hikes expected to follow, according to data from LSEG. As per Pepperstone Group's Chris Weston, "Given the degree of pricing, the rate decision itself may have limited impact on the yen. Instead, attention should fall on the forward swaps curve and the bank's guidance around the pace and urgency of further tightening."
Japanese government bond yields at the short end of the curve climbed to their highest level in more than three decades on Thursday, as investors increased bets that the Bank of Japan will raise interest rates following the U.S. Federal Reserve's latest policy tightening. According to Reuters, the 2-year JGB yield rose 2 basis points to 1.865%, its highest level since April 1995, supported by higher equivalent U.S. Treasury yields after the Federal Reserve delivered a hawkish policy signal and indicated that another rate increase could come later this year. The BOJ is widely expected to raise its policy rate by 25 basis points to 1.25% on Friday, with market pricing pointing to expectations of further quarterly increases potentially taking the key rate to around 2% over the next year. Investors will closely assess the BOJ's guidance on the pace of further monetary policy normalisation, particularly given the potential impact on the Japanese yen, as the Fed's hawkish stance triggered a sharp rebound in the dollar-yen exchange rate overnight. Governor Ueda's press conference will be key, with the market looking for confirmation that further normalisation remains firmly on the table, while assessing whether the Bank sees any urgency to move again.
Japan's inflation outlook is becoming increasingly sensitive to import costs, yen movements and supply shocks, raising concerns at the Bank of Japan. According to reports from Reuters, policymakers are assessing whether these pressures could become persistent and influence inflation expectations, as the central bank weighs further rate hikes amid changing domestic and global economic conditions. The latest developments show that Japan saw inflation spike due to rising import costs and currency shocks, suggesting such price reactions needed to factor into monetary policy considerations. Japanese government bond yields extended their rise on Wednesday as higher oil prices and escalating tensions in the Middle East heightened concerns over inflation, with the benchmark 10-year JGB yield rising 0.5 basis points to 3.035% after touching a fresh 30-year high on Tuesday. Oil prices started the day lower, with Brent crude futures off 1% at $103.76 per barrel as traders reassess supply risks after Saudi Arabia and Yemen's Iran-backed Houthis traded strikes on Thursday.
The contrasting moves in short- and long-term yields underscore the market's focus on the BOJ's near-term rate path, while easing oil prices have moderated inflation concerns at the longer end of the curve. According to Reuters, the 40-year JGB yield fell 5 basis points to 4.115%, while the 20-year yield declined 1.5 basis points to 3.84%, as falling crude oil prices eased inflation concerns. The benchmark 10-year JGB yield edged down 0.5 basis points to 2.99%, while the 5-year yield rose 1.5 basis points to 2.295%. The resulting moves across maturities led to a so-called twist flattening of the yield curve, reflecting the market's assessment of different inflation risks across various time horizons. In cryptocurrencies, bitcoin slid 0.1% to $76,442.97 while ether was down 0.2% at $2,447.39, while the Aussie dollar was 0.1% firmer at $0.7117 as Reserve Bank of Australia Governor Michele Bullock warned that risks to inflation flagged by policymakers appeared to be materialising.
The BOJ began moving away from its decade-long monetary stimulus programme in 2024, with policymakers indicating that further rate increases could be warranted if economic and price developments remain broadly consistent with the central bank's outlook. After exiting a decade-long stimulus programme in 2024, the BOJ has vowed to keep raising rates as a tight job market, rising import costs from a weak yen and higher fuel costs from the Middle East conflict heighten risk of inflation overshooting its 2% target. With inflation risks remaining elevated and the COVID-19 pandemic, Russia's invasion of Ukraine, higher U.S. tariffs and the Middle East conflict putting focus on supply-side inflation, the central bank faces growing pressure to continue its gradual normalisation of monetary policy. The BOJ is expected to raise its policy rate to 1.25%, a 31-year high, amid persistent inflation pressures linked to higher energy and import costs, representing the first increase in three months and continuing the central bank's gradual shift away from its long-standing ultra-loose monetary policy. Traders narrowly expect a hike from the Federal Reserve next month as investors say they are becoming more confident in Chair Kevin Warsh's efforts to reassert the central bank's independence from the White House, with Fed funds futures pricing an implied 53% probability of a quarter-point hike at the central bank's next two-day meeting next month, compared with a 27.2% chance a week ago.
