BOJ Raises Rates To 1.25%, Further Hikes Face A More Divided Board

In a widely expected move, BOJ decided to raise interest rates by 25 bps to 1.25% with a majority of 7-2. Two members voted against the rate hike decision. One of the members, Toichiro Asada had voted against the rate hike decision in June policy as well. This decision takes the policy rate to its highest level since 1995, following the 25-bps increase in June to 1%, with the BOJ keeping rates unchanged at its July meeting. The latest hike comes amid persistent price pressures and continued yen weakness, with underlying inflation remaining close to the BOJ’s 2% target.

Moderate Growth Outlook Ahead, Inflationary Pressures Persist

Overall Growth is expected to expand at a moderate pace in the near-term, even as higher energy prices are seen to weigh on economic activity. However, resilient domestic demand, firm business investment and stronger global AI-related demand should provide some support to growth, partly offsetting the impact of Middle East-related disruptions. On the other hand, weak housing investment and subdued household sentiment could limit the pace of growth.

Inflation outlook remains elevated in the near-term, as yen weakness and higher energy prices continue to add pressure to imported costs. Rising wages are increasing firms’ costs and could be passed through to consumer prices, while stronger AI-related demand is pushing up producer prices, particularly for semiconductors and other goods. With these factors persisting, inflation could remain sticky around 2% and potentially move above target.

US–Japan Yield Gap, Continues To Add Pressure On Yen, As USTs Continue To Run Ahead Of JGBs

The spread between US-Japan 10Y yields have moderated sharply from 2023 peak, elevated yields in the US treasury market, have continued to weigh on JPY, despite BoJ raising rates. Further, with US again on the path to tighten monetary policy, the BoJ must keep pace or continue to intervene in the Fx markets to ensure the stability of JPY. The Yen has depreciated by ~0.6% since the middle-east conflicts began. During the same period, DXY has appreciated by 2.5%. Japan has stepped up FX intervention, spending a record ~USD 96.5 Bn between late July and August. Despite the intervention, the yen remains weak, adding to imported inflation pressures.

Market Reaction

Markets reacted positively to the BOJ’s policy decision, with the Nikkei 225 gaining ~1.4% today. The yen has appreciated 1.8% MTD following the government’s FX intervention, however, depreciated 0.6% following the policy announcement, possibly due to non-unanimous vote.

Ionic Wealth View

The BoJ delivered a widely expected rate hike, although the move did little to support the JPY immediately. For Japan, currency stability remains a key priority, with the BoJ relying on tighter monetary policy alongside active FX intervention, helping the JPY to appreciate 1.8% MTD. With the US now also on a tightening cycle, managing JPY stability could become increasingly challenging, potentially prompting a faster pace of BoJ rate hikes and/or greater selling of US Treasuries in the coming months, which is something US will find hard to cheer. The divide within the BoJ Policy Board is even more crucial for future policy decisions, with two members both considered reflationists dissenting from the decision in this policy. The persistent risks around the JPY outlook could hurt flows into Japan, however, supportive fiscal policy, strong AI-related exports and still reasonable valuation should limit the downside. We remain constructive on Japan allocation within the broader global asset allocation mix, despite near-term JPY volatility risk.

(Source: BOJ, Ionic Wealth)