BOJ Rate Hike Case Strengthens as Policymakers Warn of Inflation Risks

Japan and the United States successfully conducted a rare joint yen-buying intervention that helped the Japanese currency rebound from its weakest level in four decades. The yen weakened 0.18% to 157.45 per US dollar after the coordinated intervention, though it remains stronger than levels from a week ago. This marked the U.S.'s first intervention in the Japanese forex market in 15 years, prompting official support of the Japanese exchange market. The dollar index fell 0.1% to 99.91, while the euro rose 0.11% to $1.152, as reported by Reuters. Atsushi Takeuchi, a former BOJ official involved in Japan's currency interventions between 2010 and 2012, told Reuters that the intervention's biggest impact was psychological, demonstrating that Washington was fully prepared to back Tokyo in defending the yen. Takeuchi expects the yen to trade within a range of 155 to 162 per dollar in the near term, with investors potentially viewing 160 as a new short-term floor if the currency remains stronger than that level for another week. However, some market participants have warned that the Bank of Japan's gradual rate increases and Japan's expansive fiscal policy could be a drag on the yen.

Bessent told NHK that 'part of the inflation uptick in Japan was a result of the weak yen and also the energy prices,' as reported by Reuters. The latest BOJ minutes reveal that wholesale prices accelerated in June at the fastest pace in more than three years, with the producer price index surging 7.1%. Most members saw a need to pay greater attention to inflation risks stemming from the weak yen, higher import costs and price pressures linked to strong demand for artificial intelligence-related products. Elevated fuel costs associated with the conflict in the Middle East were also seen as a potential source of additional inflationary pressure. 'Given this situation and how firms have become more active in raising prices, we must be more concerned about the risk of inflation accelerating further,' they were quoted as saying. The Treasury Secretary's comments suggest that Japan's inflation pressures are largely driven by external factors rather than domestic monetary policy, supporting the case for tighter BOJ policy.

The BOJ raised interest rates to a 31-year high of 1% at the June meeting as rising fuel costs from the Middle East conflict added to mounting inflationary pressures from a weak yen and tight job market. However, the central bank kept interest rates unchanged at its latest policy meeting but delivered one of its strongest warnings yet about the growing risk of inflation exceeding expectations, leaving the door open for a rate increase as early as September 17-18. The minutes showed two board members calling for faster interest rate hikes to push the BOJ's policy rate closer to levels deemed neutral to the economy. At a subsequent meeting in July, the BOJ kept interest rates steady but said future policy discussions would focus on upside price risks, signalling the chance of a rate hike as soon as September. Naomi Muguruma, Chief Bond Strategist at Mitsubishi UFJ Morgan Stanley Securities, told Reuters that intervention alone only slows currency moves temporarily, adding that faster interest rate increases are probably needed to establish a more durable floor under the yen, with a September rate hike now appearing highly likely. However, with 85bps worth of BoJ increases being priced in by the end of 2027, it may be hard to envision the BOJ turning even more hawkish, especially with PM Takaichi opposing rate hikes and having the ability to tilt the scales to the dovish side through future appointments within the Board.

Attention is now turning to a planned meeting between Bessent and BOJ Governor Kazuo Ueda during the G20 finance leaders' gathering later this month, just weeks before the BOJ's September policy meeting, as reported by Reuters. Bessent had previously indicated he would meet Ueda at a U.S.-hosted G20 finance leaders' meeting at the end of August, which would precede the BOJ's September policy meeting. Japanese Finance Minister Satsuki Katayama said she has spoken with US Treasury Secretary Scott Bessent around 10 times this year on issues including exchange rates, with the two also holding lengthy discussions during Bessent's visit to Japan in May. Several sources familiar with the BOJ's thinking believe the central bank is increasingly likely to raise rates either in September or October, with economists noting that if the Bessent-Ueda meeting takes place as expected, avoiding a September increase could become more difficult. The BOJ has scheduled three speaking events involving board members before its September policy meeting, with investors expected to closely monitor those appearances for indications of whether the central bank is preparing markets for another rate increase.

Despite the tightening cycle, Japanese borrowing costs remain considerably lower than those of other major economies, while real borrowing costs are negative, as reported by The Economic Times. Inflation has remained around the BOJ's 2% target for roughly four years. Critics have argued that the BOJ's cautious pace of normalisation contributed to the yen's decline to a four-decade low, increasing import costs and putting additional pressure on households and retailers. Those concerns helped push Japan's 10-year government bond yield to its highest level in three decades last month, with Takeuchi warning that the recent sell-off in Japanese government bonds has been extraordinary. The BOJ also discussed its huge balance sheet strategy, with one member calling for reducing its size steadily to avoid side-effects caused by excessive supply of money. Most economists expect the BOJ to deliver another rate increase before the end of the year, with October currently viewed as the most likely timing, although September remains a possibility.