BOJ seen holding rate as yen traders focus on intervention risk

[TOKYO] The Bank of Japan is widely expected to keep its benchmark rate unchanged on Friday (Jan 23), offering little immediate support for the yen – and keeping traders on high alert for potential foreign exchange intervention by the government as early as the same day if the currency slides.

All BOJ watchers surveyed by Bloomberg predicted the BOJ would hold its policy rate steady at 0.75 per cent at the end of its two-day policy meeting on Friday after raising it to the highest level since 1995 last month.

A focus of the meeting will be the extent to which governor Kazuo Ueda provides hawkish signals at a time when the yen is on the cusp of a key level versus the dollar. As of Tuesday morning in Tokyo, the yen was trading at 158.20 to the dollar, not far from the 160 threshold considered a rough line in the sand where authorities bought the currency in multiple rounds of intervention in 2024.

BOJ officials are paying greater attention to the impact of the currency on inflation, as further weakening could hasten the pace of future rate hikes, people familiar with the matter told Bloomberg last week.

“The BOJ is likely to suggest the hurdle isn’t very high for the next hike in order to avoid fuelling yen depreciation,” said Naka Matsuzawa, chief strategist at Nomura Securities. “They will probably leave room to act as soon as April.”

On the same day as the board’s policy decision, Prime Minister Sanae Takaichi will dissolve the lower house of parliament to make way for a snap election on Feb 8. Market speculation that she might lead her Liberal Democratic Party to a strong result and proclaim it a mandate for more expansionary fiscal spending has weighed on the yen and government bonds while boosting stock prices to a record high.

The yen has weakened about 7 per cent against the US dollar, the most among major currencies tracked by Bloomberg, since early October, when Takaichi, a proponent of fiscal and monetary stimulus, first emerged as a leading candidate to become prime minister. She ultimately achieved that role later that month.

While the BOJ was the only major central bank that raised rates last year – doing so twice – the moves failed to turn the tide for the yen. Japan’s interest rate remains the second-lowest among major economies after those in Switzerland. 

Pricing in the overnight swaps market indicates that traders see about a 58 per cent chance of the BOJ’s next hike coming by April, a jump compared with around 38 per cent who foresaw that timeline back in December. July was the most popular timing for the next move among surveyed economists, with the yen floating as an X factor that could quicken the timing.

The BOJ will potentially raise interest rates three times this year if the yen’s weakness persists, Akira Hoshino, Citigroup’s markets head for the country, said in an interview.

Finance chief Satsuki Katayama and top currency official Atsushi Mimura suggested last week that authorities are becoming increasingly concerned by stepping up verbal warnings.

The likely highlight this week will be Ueda’s press briefing. Traders will watch to see if it unfolds similar to what happened in September 2022, when Ueda’s predecessor Haruhiko Kuroda made comments after holding settings steady that invited further yen weakness. Within an hour of the briefing, the Finance Ministry bought the yen for the first time since 1998.

“I’m closely watching if there will be a hint of hawkishness or warning shots related to the weak yen,” said Tsuyoshi Ueno, chief economist at NLI Research Institute.

Ueda will need to conduct a balancing act. With Takaichi inclined to support monetary easing, and with an election looming, the governor will probably refrain from telegraphing a faster pace of rate hikes at this point, according to Ryutaro Kono, chief Japan economist at BNP Paribas.

But if he’s too dovish, yen bears will pounce. Still, market data suggest participants have relatively mixed positions, which could limit the scope of moves. 

Leveraged funds were net short the yen by US$8.1 billion as of Jan 13, while asset managers were net long by US$2.4 billion, according to US Commodity Futures Trading Commission data. 

Washington will be watching closely. Treasury Secretary Scott Bessent suggested that Japan should stay on track for normalization by mentioning earlier this month the need for “sound formulation and communication of monetary policy.” He expressed similar sentiments in October.

Ueda indicated his intention to conduct more rate hikes in his first speech of the new year, and he has ample grounds to do so. Inflation figures due Friday are forecast to show that prices have run above the BOJ’s 2 per cent target for four straight calendar years, offering compelling evidence that inflation is taking hold.

The BOJ will update its quarterly outlook this week. Authorities are likely to boost their economic growth projection in light of the large-scale stimulus package that Takaichi pushed through parliament in December, people familiar with the matter told Bloomberg earlier this month. 

Surveyed economists don’t expect the bank to make major changes to its price outlook even as the yen’s recent slide exerts upward pressure. The central bank is likely to maintain its forecast for achieving the 2 per cent price target in the second half of the three-year projection period that runs through March 2028.

In addition to the stimulus package, Takaichi also compiled a full-year budget for fiscal 2026 that is the biggest ever, tapping into tax revenue that has risen thanks to inflation. As a result, the premier will lower the ratio of government debt against the size of the economy.

The premier plans to take another step to offset inflation by pledging in her election platform to conduct a temporary cut to the sales tax on purchases of food. Government bond yields spiked on news of this idea Monday, with yields on 5-year, 30-year and 40-year bonds touching the highest levels on record. As for the impact on data, Capital Economics says such a move could turn inflation negative.

Makoto Sakurai, a former BOJ board member, is of the view that Takaichi’s fiscal measures are too expansive for an economy already in the grips of inflation and will likely wind up boosting the cost of living via currency moves.

The yen’s role in driving monetary policy decisions has long been an unspoken reality in Japan, according to Daisuke Karakama, chief market economist at Mizuho Bank. However, the prospect of the yen playing that role at a time when the government needs to defend its currency gives rise to “a serious sense of alarm.”

“The choice ultimately comes down to one of two pains: higher interest rates or a weaker yen,” Karakama said. “Since one of these must be borne, the final judgment will likely rest with politicians rather than with the central bank.” BLOOMBERG