In an interview published last Saturday, Bank of Japan Governor Kazuo Ueda stated that if the economic performance meets the forecast, the Bank of Japan will implement its third rate hike this year. The market expects the US Federal Reserve to continue its rate cut by one notch this month, and the continued narrowing of the US-Japan interest rate differential may help the yen continue to appreciate.
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ToggleWill the Bank of Japan raise rates for the third time this year?
Since taking office in April 2023, Bank of Japan Governor Kazuo Ueda has made 2024 a milestone year. He ended the central bank's large-scale monetary easing program in March and raised rates for the first time in 17 years. Ueda raised rates again by 15 basis points in July, surprising many with his hawkish approach, which triggered unwinding of yen carry trade and a global stock market correction.
The next rate hike will raise the Bank of Japan's policy rate from 0.25% to 0.5%, the highest level since 2008, representing a significant change after maintaining a negative rate of -0.1% for an extended period.
According to Bloomberg, in the media interview on Saturday, Ueda said he is closely monitoring wage negotiations and any risks to the US economy, as Japanese authorities try to achieve a soft landing during the political transition period. The strong wage growth achieved this spring was a driver for the central bank's decision to start reducing stimulus in March.
The US-Japan interest rate differential will continue to narrow
The interest rate differential between the US and Japan is likely to narrow this month due to policy actions by both sides. As of Monday, traders see a 67% chance of the Fed cutting rates and a 61% chance of the Bank of Japan raising rates, doubling from a month ago.
Ko Nakayama, chief economist at Okayama Securities and a former Bank of Japan official, believes the next rate hike could come in December, as the Bank of Japan has stated it will take action if the economy meets its official forecast. There is increasing evidence to support this. However, if the Fed acts while the Bank of Japan does not, this could highlight the central bank's cautious stance and weaken the yen, which could also be a source of turmoil and disrupt financial market stability.
Some economists also believe that the current political factor of the ruling coalition losing its majority may cause the Bank of Japan to delay its rate hike action until January.
The Bank of Japan will announce its rate decision on 12/19, while the Fed will conclude its FOMC meeting a day earlier on 12/18.
Will the era of cheap yen come to an end?
Due to Japan's long-standing low-rate policy, the yen has been used by investors as a tool for carry trade, which is one of the main reasons for the yen's long-term depreciation. The yen has been on a downward trend since 2021, with the USD/JPY exchange rate breaching the 160 level several times in July this year. Japan intervened in the foreign exchange market in May to prevent the yen from depreciating further.
Note: Carry trade refers to the practice of borrowing money in a low-interest-rate country (such as Japan) and converting it into a higher-interest-rate currency (such as the US dollar) to profit from the interest rate differential.
The Nikkei 225 index has risen by nearly 20% this year, making it one of the best-performing major indices globally. The inflow of funds, combined with the narrowing of the US-Japan interest rate differential, will help support the yen's appreciation, although the interest rate differential is still significant, limiting the upside potential in the short term.
Has the era of cheap yen officially come to an end? It can only be said that the previous historical lows of the yen have caught the attention of the Bank of Japan and the government, and have also impacted the livelihood of the Japanese people. The yen is unlikely to continue to depreciate in the long term.
(This article is not investment advice, please DYOR)
