The Japanese government's latest stance signals a recognition that foreign exchange intervention alone cannot sustain the yen's strength; the pace of the Bank of Japan's (BOJ) rate hikes is now the critical factor for yen stabilization. There is a consensus between the government and the BOJ on the need for a near-term rate increase, with the next potential windows pointing to the September 18 or October 29-30 BOJ meetings. Market pricing now places a 74% probability on a September rate hike. This marks the first time the Japanese government has explicitly signaled its support for a rate increase.
US Treasury Secretary Scott Bessent has previously indicated that BOJ action to boost the yen is "necessary," showing Washington's openness to Japan's tightening policy shift. The dollar-yen pair once fell sharply by over 200 points. Market participants believe the Japanese government's statement reflects an understanding that unilateral forex intervention is unsustainable, and the BOJ's rate hike pace is key to yen stability. However, significant disagreement remains over the exact timing—whether the hike will occur in September or December.
Market participants also warn that the biggest tail risk for global markets from this policy shift is the potential for an unexpected tightening amid crowded yen carry trades, which could trigger a liquidity shock similar to the "yen surge leading to a global asset stampede." The rationale for this alignment between the government and the BOJ includes two main factors: the BOJ's concern that persistent yen weakness will exacerbate imported inflation, and the government's desire to amplify the effects of the joint US-Japan forex intervention from July 31. While the BOJ has legal independence in monetary policy, the cabinet cannot set interest rates, but the government can exert influence through signals.
Previously, Prime Minister Shigeru Ishiba's administration was cautious about rapid rate hikes, mainly due to concerns about Japan's economic recovery. However, the yen's depreciation, which has raised living costs, has driven the cabinet's approval rating to its lowest since taking office, with dissatisfaction rates surging from 56% to 71%, creating political pressure that forces a policy shift. It is reported that before the July BOJ meeting, the government conveyed support for BOJ Governor Kazuo Ueda to deliver a more "hawkish" stance in his post-meeting press conference. Ueda indeed mentioned the "possibility of accelerating the pace of rate hikes," citing risks of upward price pressures.
If the BOJ raises rates between September and October, it would mark three rate hikes in 12 months, the fastest tightening pace since 1989. Under the Ishiba administration, the BOJ has already raised rates twice, but the benchmark rate remains at a low 1%, with real borrowing costs still negative. Tomo Kinoshita, Global Market Strategist at Invesco Japan, told Yicai that in the latest Economic and Price Outlook Report, the BOJ emphasized that core inflation may exceed its 2% target and negatively impact economic activity. Ueda hinted at a possible faster pace of rate hikes, moving away from the previous roughly six-month interval.
"The BOJ's gradual rate hike policy was not only due to the need to assess each hike's unintended consequences but also political pressure from the Ishiba administration, which favored an accommodative stance. However, the US's willingness to participate in coordinated yen intervention, beyond reflecting concerns about yen depreciation, also suggests it may welcome tighter BOJ policy," Kinoshita said. He added that the government now appears to have reduced its constraints on BOJ rate hikes due to US influence, creating a more favorable environment for further tightening. Based on recent developments, he expects the next BOJ rate hike to be moved up from December to October. Financial markets are gradually pricing in this possibility, providing upward momentum for the yen.
Hideo Kumano, Chief Economist at Dai-ichi Life Research Institute, noted that the current policy rate of 1% is still below the BOJ's estimated neutral rate range of 1.1% to 2.5%. A hike to 1.25% in September or October would officially push it above the neutral rate, entering a substantive tightening zone. However, insufficient economic data in September-October, such as corporate half-year reports typically released in November, makes a December hike a more cautious mainstream scenario. Among Wall Street banks, Citigroup predicts a "policy regime shift" by the BOJ, with a more aggressive rate hike pace starting in September, targeting a rate of 2% by the end of 2027—a path not yet fully priced by the market. Masayuki Nakajima, an analyst at Mizuho Securities, still believes that from a domestic economic perspective, the September action threshold is high, with lingering concerns about the impact of rate hikes on mortgage households and SMEs. Thus, Mizuho's base case remains a December hike. Naohiko Baba, an analyst at Barclays, sees an October rate hike as the base scenario but also warns to "stay alert for a September hike."
On the impact on yen trends and global markets, the Japanese government previously conducted unilateral forex interventions between April 28 and May 27, consuming 11.73 trillion yen in reserves, and the latest round in late July set a new record in intervention amounts. However, the yen's depreciation trend persists, indicating that isolated forex intervention is ineffective, and narrowing the US-Japan interest rate differential is a more sustainable tool for currency stability. Kinoshita told Yicai that the likelihood of further Fed rate hikes this year is low. Based on this, ongoing BOJ rate hikes will help narrow the US-Japan interest rate differential and support the yen. Invesco expects the dollar-yen to trade in the 150-155 range by the end of 2026. He added that the market's biggest fear is not the rate hike itself, but an unexpectedly rapid tightening pace combined with fiscal risks, triggering a sharp yen appreciation and a carry trade unwind similar to a "Truss moment" liquidity shock, posing systemic risks to global risk assets.
Van Luu, Global Solutions Strategy Director at Russell Investments, also warned that the latest US-Japan joint intervention, lacking coordination from the European Central Bank, has weakened its "unified voice" and the effect is fading. Sustained support would require "more measures." Moreover, with concentrated yen short positions and low valuations, if the Fed pivots dovish in sync with the BOJ's hawkish stance, the risk of a rapid yen carry trade unwinding cannot be ignored. This scenario resembles the volatility in global financial markets in August 2024, triggered by a sharp yen surge. In early July, Goldman Sachs was extremely bearish on the yen, forecasting dollar-yen at 165 over 12 months, with a 3-month target of 162 and a 6-month target of 163. In its latest August institutional views, Goldman warned that Japan's largest forex intervention in 15 years has triggered a tactical reduction in yen carry trade positions, exceeding the initial unwinding after the July 2024 intervention, with further unwinding pressure possible.
Ayako Fujita, Chief Japan Economist at JPMorgan, is relatively neutral, arguing that there is no need to worry about a carry trade stampede in the short term. "Even if the BOJ accelerates its rate hike pace, the short-term interest rate differential will remain sufficiently wide. Therefore, the likelihood of a rapid and large-scale unwinding of yen carry trades is relatively limited," she said. "Convergence of long-term JGB yields with other major economies is a longer-term story and does not pose a systemic shock in the short term."
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