BoJ’s Rate Hike Fails to Halt Yen Slump, FX Intervention Remains Possibility to Avoid Inflation Rebound

The Bank of Japan (BoJ) raised its benchmark short-term rate for the first time in 17 years yesterday, but dovish guidance from the central bank wiped out a small rally in USD/JPY and sent the Nikkei 225 back above 40,000. Japan’s inflation-adjusted real rates are still well into negative territory and pale in comparison to real US rates, which have played a role in sending the Yen close to a 33-year low against the Dollar. Pressure on the Yen would likely be further intensified if projections from today’s FOMC meeting turn out to be more hawkish than expected.

Though inflation has fallen in spite of ongoing JPY depreciation, intervention by Japanese authorities to stabilize the currency could be undertaken again like it was in 2022. Inflationary pressure could also come from a sudden and substantial rise in wages for 7 million workers, negotiated earlier this month by Japan’s largest trade union. If persistent Yen weakness and compensation costs re-ignite price growth, the BoJ may be pressured into further rate hikes.

Related ETFs: Invesco CurrencyShares Japanese Yen Trust (FXY), iShares MSCI Japan ETF (EWJ), iShares Currency Hedged MSCI Japan ETF (HEWJ)

Policymakers at the Bank of Japan (BoJ) raised its benchmark short-term rate for the first time in 17 years yesterday in a 7-2 vote. That ended a long-standing regime of negative interest rates and yield curve control (YCC) which had been in place since 2016. However, the decision did little to hold back the ongoing collapse of the Yen (JPY) versus the US Dollar (USD). The price for one USD in JPY terms had surged to nearly 151.80 by this morning, a 2024 high and close to the steepest USD/JPY exchange rate witnessed in over 33 years. In the last twelve months alone, elevated rates in the US bolstered the greenback and pushed USD/JPY up by over 15.5%.

The US Federal Reserve’s ongoing tightening regime, which is one of the most aggressive in American history and has lifted the Fed Funds rate to a multi-decade high, boosting the Dollar against most major currencies in 2022 and most of 2023. The image of the Dollar’s strength or weakness is often illustrated through the US Dollar Index (DXY). DXY is comprised primarily of the Euro at a 57.6% weighting, but the second-largest holding is the Yen, carrying a 13.6% weighting. The structure of the DXY, therefore, suggests rapid depreciation in the Yen played a material role in the index’s strength. DXY could be further influenced by JPY’s trajectory in the future.

Exchange rates often follow the direction of the real interest rates impacting each currency. For this report, we will define inflation-adjusted or “real rates” as the difference between the short-term policy rate of a central bank and the inflation rate within that bank’s country of jurisdiction. Real rates are a significant consideration when approaching foreign exchange markets because, however enticing a…