The Bank of Japan has moved to raise interest rates as prices rise and the yen remains under pressure

The Bank of Japan (BoJ) will announce its decision on monetary policy on Tuesday around 3 p.m. Polish time.

The BoJ is widely expected to live up to its expectations a hawkish move to augment the benchmark interest rate by 25 basis points (bp) to 1%, the highest level since 1995. The augment is intended not only to address rising inflation pressures, but also the strengthening of the Japanese yen (JPY).

Governor Kazuo Ueda, who was hospitalized last week, will not attend the monetary policy meeting. Deputy Governor Ryozo Himino will chair the political meeting, while Deputy Shinichi Uchida will hold a news conference after the decision is made.

Before the announcement, USD/JPY is trading above the 160.00 level, which is a sand line for Japanese authorities as it is usually seen as an intervention level.

Finally, the crisis in the Middle East has reached a turning point: The United States (US) and Iran have reached an agreement which will reopen the Strait of Hormuz and extend the ceasefire for another 60 days, allowing talks to continue. Financial markets are confident ahead of the announcement, which results in a slight weakening of the US dollar (USD) on all currency exchanges.

What can you expect from the BoJ’s interest rate decision?

An interest rate hike has long been priced in, meaning the augment itself should have a restricted impact on the yen. However, Japanese policymakers will also discuss the BoJ’s plan to limit purchases of Japanese government bonds (JGBs) to allow longer-term interest rates to be more determined by the market. Their decision on this matter could determine the short-term direction of the yen.

Japan’s annual inflation as measured by the Consumer Price Index (CPI) was 1.4% in April this year, down from 1.5% in March. However, wholesale inflation rose to 6.3% in May, a clear sign that inflationary pressures are likely to continue despite the potential end of the Iran war at the end of this week.

But it’s not just about higher oil prices: the significant depreciation of the yen also causes inflation resulting from almost all imported goods and raw materials. The BoJ’s mandate is clearly focused on this issue: “The Bank of Japan, as the central bank of Japan, decides and implements monetary policy to maintain price stability”, guided by an annual inflation rate of 2%.

That being said, the current CPI of 1.5% y/y may not be enough to justify a rate hike, but wholesale prices and yen weakness are.

BoJ Governor Ueda said this before his hospitalization policymakers should not look at oil prices in isolationnoting that fleeting energy shocks can be constant and affect wages, expectations and pricing behavior.

“If inflation expectations are already high and wages are accelerating, the risk of second-round effects is high,” Ueda said, adding that the line between fleeting and constant inflation is not mechanical

How might the Bank of Japan’s monetary policy decision affect USD/JPY?

As mentioned earlier, market participants have already priced in a 25 bp rate augment. All decisions regarding future bond purchases are partially discounted. Japanese policymakers usually do not surprise investors and are too cautious. With this in mind and taking into account that the press conference will be hosted by Deputy Shinichi Uchida, The BoJ announcement will likely have a restricted impact on the yen.

Valeria Bednarik, Chief Analyst at FXStreet, notes: “The USD/JPY pair is trading around the 160.00 level, maintaining a positive bias despite easing market concerns dampening USD demand. The daily chart of the pair shows a bullish 20-day simple moving average (SMA) heading north, well above the 100- and 200-day SMAs. The same chart shows that the technical indicators have lost their upward momentum. but they remain above the midline, lacking any directional strength that the 20-day SMA has attracted buyers and is currently providing near-term support at around 159.65.”

Bednarik adds: “Once above mentioned animated support, the pair could extend its decline towards 159.00, while additional selling pressure could cause the pair to reach the immobile support level of 158.60. The USD/JPY pair peaked at 160.73 in April, which is a multi-decade high and a critical level to watch in case of further weakening of the yen. Next comes the 161.00 level, although it seems unlikely that “Japanese authorities allowed the currency to depreciate so much without actually intervening in the market.”

Japanese Yen FAQs

The Japanese yen (JPY) is one of the most frequently traded currencies in the world. Its value is largely determined by, among other things, the performance of the Japanese economy, but in particular the policy of the Bank of Japan, the difference between the yields of Japanese and American bonds, and the risk sentiment of investors.

One of the tasks of the Bank of Japan is currency control, so its movements are crucial for the yen. The BOJ has at times intervened directly in currency markets, generally to depress the value of the yen, although it often refrains from doing so due to the political concerns of its major trading partners. The BOJ’s ultra-loose monetary policy in 2013–2024 resulted in the depreciation of the yen against other major currencies due to the growing policy divergence between the Bank of Japan and other major central banks. More recently, the gradual withdrawal from this ultra-loose policy has provided some support to the yen.

Over the past decade, the BoJ’s stance of sticking to ultra-loose monetary policy has led to widening policy divergences with other central banks, particularly the US Federal Reserve. This supported a widening spread between US and Japanese 10-year bonds, which supported the US dollar against the Japanese yen. The BoJ’s decision to gradually exit ultra-loose policy in 2024, combined with interest rate cuts at other major central banks, narrows the gap.

The Japanese yen is often viewed as a safe-haven investment. This means that in times of market stress, investors are more likely to put their money into the Japanese currency due to its supposed reliability and stability. The turbulent times are likely to strengthen the value of the yen relative to other currencies considered riskier to invest in.

Economic indicator

BOJ press conference

The Bank of Japan (BoJ) holds a press conference at the end of each of its eight scheduled policy meetings. During the press conference, the BOJ president talks to media representatives and investors about monetary policy. The Governor discusses factors influencing the latest interest rate decision, the overall economic outlook, inflation, and guidance for future monetary policy. Hawkish comments tend to strengthen the Japanese yen (JPY), while dovish messages tend to weaken it.