Bank of Japan raises rates as expected, yet the yen plunges! Even with the fastest tightening since 1990, the market still cries "not hawkish enough."

Title context: Bank of Japan raises rates as expected, yet the yen plunges! Even with the fastest tightening since 1990, the market still cries "not hawkish enough." Text: The Bank of Japan followed the Federal Reserve's rate hike on September 18, announcing a 25 basis point increase to 1.25% as the market had expected. Previously, on September 16, the Federal Reserve implemented its first rate hike in about three years, raising the target range for the federal funds rate by 25 basis points to 3.75%4.00%; the European Central Bank likewise raised rates by 25 basis points on September 10, lifting the deposit facility rate to 2.50%. The Bank of England, meanwhile, announced on September 17 that it would keep rates at 3.75%, but three of its nine members favored a hike. Together, these moves show that concerns about inflation across countries are converging, even as the specific pace of tightening still differs. After the Bank of Japan raised rates, the yen instead fell. The key was that the tightening the market had previously anticipated exceeded the signal released by this decisionthat is, a rate hike the market had already expected does not necessarily bring fresh upward momentum for the currency. The 25 basis point hike had long been largely priced in, and two dissenting votes plus the absence of new hawkish guidance weakened the market's judgment that the Bank of Japan would act quickly in succession. At the same time, the Federal Reserve also raised rates by 25 basis points this week. Based on the two sides' policy rates, the U.S.-Japan interest rate differential remains 2.502.75 percentage points, the same as before both sides raised rates this week. If U.S. rate expectations continue to move higher in the future while Japan's tightening pace fails to keep up, USD/JPY may still find support. Therefore, USD/JPY at the 160 level is a conditional upside scenario put forward by strategists; the precedent of joint U.S.-Japan intervention, along with officials' attention to the speed of depreciation and disorderly moves, would in turn affect investors' willingness to build yen short positions. The core of what the market trades next is changes in the two countries' future rate paths and expectations for currency intervention. High energy prices are an important common backdrop for this round of policy adjustments. The Bank of England recorded that Brent crude oil had reached $106 per barrel on September 14, and warned that the energy shock could continue to pass through to broader prices. Inflation concerns and tightening expectations also drove repricing in long-end bondson September 15, the yield on the 10-year U.S. Treasury, the "anchor of global asset pricing," briefly rose to 5.041%, a new high since 2007; Japan's 10-year government bond yield touched 3.036%, a roughly 30-year high; and the U.K. 30-year yield briefly reached 5.96% this week, the highest since 1998. However, after the Bank of England adjusted its government bond sales arrangements on the 17th, the U.K. 30-year yield has fallen back to about 5.74%. Oil prices make this policy game even more complicated. JPMorgan said on September 17 that the prolonged Iran conflict made it difficult to establish a clear baseline scenario for the oil market; the bank estimated the fair value of Brent crude in September at about $90 per barrel, significantly below the current market price of about $106, which includes concerns about further supply disruptions. Compared with other developed-market central banks, the Bank of Japan seems to need even more to assess simultaneously the impact of higher energy prices on inflation and real purchasing power: the longer the shock persists, the greater the risk of pass-through to other goods and services prices and wages; but for Japan, which relies on energy imports, higher import costs may also squeeze corporate profits and households' spending capacity. This two-sided nature helps explain why the Bank of Japan is raising rates while still remaining cautious about the pace ahead. Two dissenting votes as the Bank of Japan raises rates, yen extends decline After the Bank of Japan raised rates as expected, the yen extended its decline against the dollar, with two dissenting votes casting doubt on the prospect of further monetary tightening. The yen fell 0.7% after the Bank of Japan's decision, to 157.09 per dollar. Although all economists surveyed by Bloomberg expected the Bank of Japan to take this action, the vote was 7 to 2, with policy board members Toichiro Asada and Ayano Sato voting against. Chidu Narayanan, chief Asia-Pacific strategist at Wells Fargo, said the outcome was "not hawkish enough for the market and should push USD/JPY higher and short-end yen yields lower." "There were two dissenting votes at this meeting, and although they came from the two most dovish members of the board, this does not support the market's expectation that the Bank of Japan will raise rates quickly in succession." Before this rate hike by the Bank of Japan, the Federal Reserve's hawkish rate hike earlier this week had already pushed the yen weaker, partially reversing the yen's strong gains earlier this month. Factors that had previously driven the yen higher included market expectations that the Bank of Japan would accelerate policy tightening, the unwinding of carry trades funded in yen, and speculation that Japanese pension funds might shift more money into domestic assets. Traders will focus on Bank of Japan Governor Kazuo Ueda's press conference after the decision for clues on the speed and scale of further tightening. The press conference usually begins at 3:30 p.m. Tokyo time. Masahiko Loo, senior fixed income strategist at State Street Investment Management, said: "I expect his language to remain neutral to slightly hawkish, and to emphasize that given resilient economic growth, persistent inflation risks, and the fact that a policy rate of even 1.25% is still accommodative, every subsequent meeting could bring a rate adjustment." Strategists said that if investors conclude the Bank of Japan's tightening pace will struggle to keep up with the Federal Reserve, USD/JPY could climb toward 160. Given that the 25 basis point hike had already been largely priced in, this risk would be especially prominent if the Bank of Japan's subsequent communication is interpreted as dovish. The latest decline has also put intervention risk back in focus. Japan and the United States carried out their first coordinated yen-buying operation since 1998 this summer. Officials emphasized the speed and disorderliness of exchange-rate moves rather than any specific level, but another approach toward 160 could test their tolerance. Neil Newman, head of strategy at Astris Advisory Japan, said: "If the yen comes under pressure again and breaks below 160 per dollar, we should expect Japan and the United States to intervene in the foreign exchange market again." Data from Japan's Ministry of Finance showed that in the month through August 26, Japan spent a record 15.4 trillion yen, or about $98.3 billion, to intervene in the currency market. Since then, U.S. Treasury Secretary Scott Bessent has continued to signal support for a stronger yen, which may further discourage traders from rebuilding yen short positions. Bank of Japan raises rates at fastest pace since 1990 after Bessent's calls The Bank of Japan raised its benchmark interest rate, accelerating the pace of hikes to the fastest in 36 years, in response to rising inflation risks and unusually explicit calls from Washington for further progress on policy normalization. A Bank of Japan statement showed that at the end of its two-day meeting, the central bank raised its policy rate by 25 basis points to 1.25% on Friday. All economists surveyed by Bloomberg expected the move. The vote was 7 to 2, with policy board members Toichiro Asada and Ayano Sato dissenting. The action had been well telegraphed beforehand, and after it was announced the yen weakened against the dollar to 156.95 per dollar. There was no obvious sign in the statement that the language had become more hawkish, and it therefore failed to provide momentum for bullish yen bets. As shown in the chart above, the Bank of Japan joined the Federal Reserve and the European Central Bank in raising rates. This action came just three months after the Bank of Japan's previous rate hike, the shortest interval between two hikes since 1990. That year, the Bank of Japan tightened policy rapidly, which played an important role in the bursting of Japan's asset bubble. This was the sixth rate hike during Kazuo Ueda's tenure as governor, making him the Bank of Japan governor with the most rate hikes in at least half a century. The hike followed a series of pressure campaigns by U.S. Treasury Secretary Scott Bessent urging Japan to raise interest rates. The Bank of Japan also accelerated its rate hikes as the global monetary policy backdrop shifted amid authorities' response to the impact of the Iran war. The Federal Reserve implemented its first rate hike in three years on Wednesday and initially projected another increase later this year, underscoring the change. The European Central Bank carried out its second rate hike this year last week. Japan's move marks the first time the Bank of Japan, the Federal Reserve, and the European Central Bank have raised borrowing costs in the same month. These synchronized actions also highlight that the Bank of Japan has largely changed its long-standing position of standing apart from the global monetary policy mainstream. The rate hike produced few surprises, as a string of remarks by Bessent had already helped solidify market expectations for the move. Although the yen weakened against the dollar shortly after the decision, it remained stronger than its July level. Coordinated intervention by the United States and Japan at the end of July helped push the yen further away from the roughly 40-year low of 163.99 per dollar reached on July 23. The Bank of Japan reiterated that it will continue raising rates if its outlook for the economy and prices is realized. With the policy rate at 1.25%, it will enter the lower edge of the central bank's estimated neutral rate range for the first time. The neutral rate is regarded as the interest rate level that neither stimulates nor restrains the economy. Before the policy board meeting, Bessent made repeated remarks supporting action by the Bank of Japan, helping fuel expectations for a rate hike, and by early September the market had almost fully priced in the move. According to the U.S. Treasury Department, when Bessent met face-to-face with Kazuo Ueda in North Carolina last month, he "expressed strong support" for Japan taking decisive measures to address the yen's weakness. The chart above shows that the market consensus expects Japan's inflation rate to remain above the Bank of Japan's target. Note: All are calculated on a fiscal year basis. As of 2025, a key Japanese inflation gauge has remained above 2% for the fourth consecutive year, and the Bank of Japan expects inflation to continue exceeding its target in the coming years. Data released earlier on Friday showed that core inflation slowed slightly in August, partly due to distortions caused by subsidies. Analysts expect price growth to accelerate to nearly 3% by early next year. Kazuo Ueda will explain the considerations behind Friday's decision and the interest rate path for the coming months at a press conference usually beginning at 3:30 p.m.