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According to a report from Japan's Jiji Press citing informed sources, the Bank of Japan may discuss another interest rate hike during its September 17-18 monetary policy meeting. If finalized, this would mark the BOJ's second policy tightening move following its June rate increase. The sources indicated that rising upside risks to inflation are a key factor driving the central bank to consider further action. This news has reinforced recent market expectations of a more hawkish shift within the BOJ. Earlier, the summary of opinions from the BOJ's July policy meeting had already signaled a hawkish stance, boosting market bets on a September rate hike. Additionally, the recent joint Japan-U.S. intervention in the foreign exchange market has added pressure on the BOJ to act. Market participants believe that if Japan aims to support the yen through currency intervention, it must be accompanied by genuine monetary policy tightening; otherwise, intervention may only provide short-term effects.
The conflict between rate hikes and bond market pressure creates a policy dilemma
The Bank of Japan is facing a more complex balancing act. On one hand, the central bank seeks to continue normalizing monetary policy by raising interest rates to combat inflation risks. On the other hand, the Japanese government's expansionary fiscal policies are driving up Japanese government bond yields and increasing political pressure on the BOJ to resume large-scale bond purchases. Prime Minister Shigeru Ishiba's push for fiscal expansion has sparked market concerns about Japan's debt sustainability, pushing JGB yields higher. As one of the most heavily indebted developed economies, rising borrowing costs could further strain government debt servicing, while also drawing attention from the U.S. regarding potential spillover effects from Japanese bond market volatility. Last month, Ishiba stated that the government would strengthen communication with the market to maintain investor confidence in Japan's fiscal health. Japanese media reported that in May, Ishiba requested BOJ Governor Kazuo Ueda to increase bond purchases if necessary to curb rising long-term yields. Subsequently, several policy advisors close to Ishiba expressed concerns about the pace of bond yield increases and the BOJ's balance sheet reduction. In July, a reflationist aide to Ishiba said the government was closely monitoring bond yield trends and had conveyed to the BOJ investors' worries about the central bank's "too rapid" reduction of its bond holdings. Toshihiro Nagahama, an economic advisor to the Ishiba administration, stated, "The Ishiba government places more emphasis on the quantitative aspects of monetary policy rather than traditional tools like rate hikes." Another Ishiba ally, Economics Minister Minoru Kihara, warned in the June policy meeting minutes about the potential economic impact of balance sheet reduction and called for policymakers to prioritize market stability. Some analysts believe such political pressure may have already influenced the BOJ's policy pace. The BOJ's decision to pause its bond reduction plan for the next fiscal year alongside its June rate hike is seen as an attempt to balance monetary normalization with bond market stability.
The BOJ resists returning to an era of massive bond buying
Analysts suggest that a resumption of large-scale bond purchases by the BOJ would conflict with its recent direction of exiting unconventional stimulus policies. The BOJ ended its yield curve control policy in 2024 and initiated a bond reduction plan, a key part of its gradual return to normal monetary policy. Re-entering with large-scale bond purchases to suppress yields could damage the credibility of the central bank's policy transition and undermine its efforts to restore normal bond market functioning. The BOJ currently emphasizes that it will only take emergency bond purchase measures when yields deviate significantly from economic fundamentals and threaten financial stability. A recent BOJ research paper indicates that the current rise in yields is mainly driven by inflation factors, not the central bank's reduction in bond purchases. The June policy meeting minutes also show that some board members have begun discussing the final size of the BOJ's balance sheet, indicating that the normalization process is still underway. One member noted in the minutes, "If the market interprets the BOJ's bond purchases as aimed at monetizing debt or suppressing yields, it would damage the central bank's credibility." Former BOJ official Nobuyasu Atago believes the BOJ's recent discussions on its balance sheet help address external doubts about the central bank being pressured by the government regarding bond purchase pace. However, market pressure could still force the BOJ to act. On Monday, the 10-year JGB yield rose to 2.805%, approaching the 3% key level that some analysts believe could trigger a new wave of bond selling. A source familiar with the BOJ's thinking said that while the central bank has no specific yield target, it may intervene if yields rise too quickly and in a one-sided manner, threatening financial stability. Mari Iwashita, executive rates strategist at Nomura Securities, stated, "If insufficient domestic investor demand for bonds triggers a yield surge, the BOJ may have no choice but to intervene. This is the price the central bank pays for dominating the bond market through long-term monetary easing."
Sustained yen strengthening still requires BOJ action, Goldman Sachs: Capital repatriation is unlikely to be a primary driver for yen appreciation
Following the recent joint Japan-U.S. currency intervention, the yen briefly rebounded but then weakened again. As of Monday, the dollar-yen pair was nearing the 160 level again. Market participants believe that currency intervention can influence speculative behavior but cannot change long-term currency trends. A key reason for the yen's persistent weakness is Japan's negative real interest rate and the interest rate differential between Japan and major overseas economies. The BOJ's decision to keep short-term rates unchanged in July was seen as undermining support for the yen. Since ending its negative interest rate policy in March 2024, the BOJ has spaced out its rate hikes by several months. If Governor Ueda and his colleagues can push for faster rate normalization, it could provide more stable support for the yen. However, the Japanese government's concerns about the impact of rate hikes on debt financing costs remain a significant obstacle to policy normalization. The core question for the market is whether Japan can break free from its long-term reliance on stimulus policies. If Japan's economy can unleash more investment vitality through reforms, the yen could gain stronger support; otherwise, piecemeal currency interventions will be insufficient to maintain long-term exchange rate stability.
Goldman Sachs has added a capital flow factor to the discussion on the yen's trajectory. The bank believes that Japan's policy efforts to encourage capital repatriation have not yet significantly altered investor behavior. Citing data from Japan's Ministry of Finance, Goldman Sachs noted that Japanese investors continued to post large net purchases of foreign bonds in July, suggesting that capital repatriation has not yet materialized. Goldman Sachs stated that policy-driven changes in capital flows may take longer to show up in data, so a future shift cannot be entirely ruled out. However, the bank's skepticism about large-scale, unhedged capital repatriation remains valid. The reason is that Japanese investors can still achieve relatively higher yields overseas. Therefore, Goldman Sachs believes that a more reliable path for sustained yen appreciation remains BOJ rate hikes, rather than capital repatriation or currency intervention. Goldman Sachs said that a rate hike by the BOJ next month would help provide more lasting support for the yen. Overall, a growing consensus is forming in the market: the key to the yen's future direction is not the scale of short-term intervention or whether funds are encouraged to return by policy, but whether the BOJ can narrow the interest rate gap with overseas economies through concrete policy actions.
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