Sources familiar with the matter indicate that Bank of Japan officials are open to raising interest rates at a faster pace than many economists currently anticipate, as the yen's sustained depreciation increases the risk of accelerating inflation.
While the market widely expects the BOJ to keep monetary policy unchanged at its upcoming July 31 meeting, officials are reportedly prepared to act sooner if necessary. Most observers expect the next rate hike to occur in December, following last month's increase that brought the benchmark rate to around 1%. A pre-June 16 hike survey showed about 70% of economists expected the central bank to raise rates approximately every six months.
Officials are aware of this market expectation but are not committed to any fixed timeline, according to the sources. They believe it is particularly crucial at this stage to closely monitor risks of further inflation acceleration, as underlying price pressures are finally nearing the 2% target set over thirteen years ago.
The yen strengthened slightly on Wednesday, moving to 162.69 per dollar from 163.13. Concurrently, Japan's 2-year government bond yield reached its highest level since 1995, with the 5-year yield touching 1.995%. This follows the yen hitting its lowest level against the dollar in about four decades during overnight trading, prompting renewed warnings from Japanese authorities about potential intervention.
BOJ officials continue to emphasize that monetary policy is not designed to target specific exchange rates, but the impact of currency movements on prices warrants close attention. Despite Japan's record intervention of 11.73 trillion yen (approximately $723 billion) between April 28 and May 27 to support the currency, the yen's weakness has persisted.
Traders remain skeptical that repeated government warnings will provide lasting relief for the yen. Many investors believe any intervention would only temporarily slow its decline, as the market views Japan's slow pace of rate hikes to combat inflation as a structural factor behind the currency's long-term weakness.
Junpei Tanaka, Head of Investment Strategy at Pictet Asset Management Japan, noted, "As concerns mount over the expansionary fiscal policy of the Sanae Takaichi administration, more people may conclude that relying solely on currency market intervention to curb yen depreciation has limited effectiveness."
Another factor supporting the case for faster BOJ action is growing evidence that inflation is becoming more entrenched. Officials have observed that more companies are passing on cost increases to consumers more quickly than before, reflecting a shift in corporate pricing behavior since the conflict in the Middle East escalated in late February. In this environment, renewed yen weakness could further incentivize companies to raise prices for goods and services.
Some officials also believe the central bank's policy mandate is evolving as underlying inflation approaches 2%. The focus is gradually shifting from pushing inflation higher to ensuring it stabilizes around the target level.
Market participants have already begun pricing in the possibility of faster rate hikes. Overnight index swaps (OIS) currently imply about a 72% probability of another BOJ rate hike by October, suggesting the market is alert to the risk of action before December.
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