Market expectations are widespread that the Bank of Japan will keep its benchmark interest rate unchanged on Friday, which will not provide direct support for the yen—should the yen decline, traders will be on high alert for potential foreign exchange intervention by the Japanese government as early as that same day. Every single BOJ observer surveyed by institutions predicts that the central bank will maintain its policy rate at 0.75% when its two-day policy meeting concludes on Friday. This follows the BOJ's decision last month to raise the policy rate to its highest level since 1995. The focus of this meeting will be on the degree of hawkish signaling from BOJ Governor Kazuo Ueda, as the yen approaches a critical level against the US dollar. At the time of writing, the USD/JPY rate was 158.20, not far from the 160 threshold. The 160 level is considered the approximate line in the sand that prompted the BOJ to intervene multiple times in 2024 to support the yen. A report last week indicated that officials are paying closer attention to the inflationary impact of the weak yen, as further depreciation could push up price levels and accelerate the pace of future rate hikes. "To avoid exacerbating yen weakness, the BOJ might signal that the bar for the next rate hike is not set very high," said Naka Matsuzawa, chief strategist at Nomura Securities. "They are likely to leave room for the possibility of acting as early as April." On the very day the policy board announces its decision, Prime Minister Sanae Takachi will dissolve the lower house of parliament, paving the way for a snap election on February 8th. Market speculation suggests she could lead her party to an overwhelming victory, interpreting this as a mandate for more expansionary fiscal spending. This prospect is pressuring the yen and government bonds while simultaneously pushing stock prices to record highs. Since early October, the yen has depreciated by approximately 7% against the dollar, marking the steepest decline among major currencies. This downturn began when Sanae Takachi, an advocate of fiscal and monetary stimulus, first emerged as a leading candidate for Prime Minister, eventually securing the position later that month. Despite the BOJ being the only major central bank to raise rates last year—and doing so twice—these moves have failed to reverse the yen's decline. Japan's interest rates remain the second-lowest among major economies, behind only Switzerland. Overnight swap market pricing indicates traders see about a 58% chance of a BOJ rate hike in April, up from around 38% predicted in December. Among surveyed economists, July is the most anticipated timing for the next hike, with the yen's freefall being seen as a potential wildcard that could accelerate the timeline. Akira Hoshino, head of Japan markets at Citi, stated in an interview that the BOJ could potentially raise rates three times this year if yen weakness persists. Last week, Finance Minister Tsuyoshi Kato and senior monetary policy official Atsushi Mimura expressed heightened concern, escalating their verbal warnings. The primary focus this week will likely be Governor Ueda's press conference. Traders will be watching closely for parallels to the situation in September 2022. Then, comments from former Governor Haruhiko Kuroda following a decision to hold policy steady led to further yen weakening; yet, less than an hour after that press conference ended, the Ministry of Finance intervened to buy yen for the first time since 1998. "I am closely watching for any hawkish bias or warning signals related to the weak yen," said Tsuyoshi Ueno, chief economist at NLI Research Institute. Governor Ueda faces a delicate balancing act. Ryutaro Kono, chief Japan economist at BNP Paribas, suggested that given Prime Minister Takachi's inclination toward monetary easing and the upcoming election, Ueda may refrain from signaling a faster pace of hikes at this juncture. However, if he sounds too dovish, yen bears are likely to pounce. Market data, however, shows investor positioning is relatively mixed, which might help limit the magnitude of any market swings. According to the US Commodity Futures Trading Commission, leveraged funds held a net short yen position of $8.1 billion as of January 13th, while asset managers were net long the yen by $2.4 billion. Washington will also be monitoring developments closely. US Treasury Secretary Scott Bessent stated earlier this month that Japan should stay on its path of monetary policy normalization, emphasizing the critical importance of "the reasonableness of formulating and communicating monetary policy," echoing similar views he expressed in October. In his first remarks of the new year, Governor Ueda hinted at his intention to continue raising rates, and he has solid justification for doing so. Inflation data due on Friday is expected to show that Japanese consumer inflation has exceeded the BOJ's 2% target for four consecutive years, providing strong evidence of entrenched price pressures. The BOJ will also update its quarterly growth forecasts this week. Informed sources revealed earlier this month that authorities are likely to upgrade their growth projections, partly due to the massive economic stimulus package Prime Minister Takachi pushed through parliament in December. Despite the upward pressure from the yen's recent slide, surveyed economists expect the BOJ to refrain from making significant changes to its price outlook. The central bank is likely to maintain its expectation of achieving the 2% price target in the latter half of the three-year forecast period ending in March 2028. Beyond the stimulus package, Takachi has compiled the largest-ever full-year budget for fiscal 2026, funded by increased tax revenues resulting from inflation. Consequently, Takachi aims to reduce the government's debt-to-GDP ratio. In another measure to curb inflation, Takachi has pledged in her campaign platform to temporarily reduce the sales tax on food. In response to these developments, Japanese government bond yields surged on Monday, with yields on 5-year, 30-year, and 40-year JGBs all hitting multi-year highs. Regarding the impact on economic data, Capital Economics suggested this tax cut could potentially push inflation into negative territory. Former BOJ official Makoto Sakurai believes Takachi's fiscal measures are overly expansionary for an economy already grappling with inflation and are likely to increase living costs through exchange rate fluctuations. Daisuke Karakama, chief market economist at Mizuho Bank, noted that it's an open secret the yen plays a pivotal role in Japan's monetary policy decisions. However, the prospect of the yen again assuming this role precisely when the government needs to defend the currency is "deeply concerning." "Ultimately, the choice boils down to one of two painful options: higher interest rates or a weaker yen," Karakama said. "Since one of these pains must be endured, the final decision may rest more with politicians than with the central bank."
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