The governor of the Bank of Japan, Kazuo Ueda, highlighted upside risks to inflation during a press conference following the July 31 policy meeting, stating that underlying inflation is approaching the 2% target and the central bank will avoid falling behind the economic curve. He explicitly noted that if financial conditions become excessively accommodative, the BOJ may quicken the pace of interest rate increases.
Ueda also pointed out that while the risk of returning to deflation has significantly diminished, it has not been entirely eliminated. He specifically mentioned that central banks in the US and Europe are moving toward tightening under the influence of Middle East tensions, while the impact of exchange rates on inflation is becoming more pronounced and requires closer monitoring. A small number of companies have reported that rising borrowing costs are constraining investment, and exchange rates remain a key variable influencing prices.
He stressed the need to be more vigilant about price increases going forward and plans to begin in-depth discussions on this at the next meeting. He also indicated he would avoid commenting on daily market fluctuations. Ueda noted that appropriate monetary policy is essential for maintaining yield curve stability and stated that the likelihood of reintroducing yield curve control measures in the near term is low.
Additionally, he said the central bank will continue to monitor the impact of the Kumamoto earthquake on the economy but does not expect it to cause serious funding supply problems.
This statement followed the BOJ's latest interest rate decision. On Friday, the central bank kept its benchmark rate unchanged at 1%, in line with expectations from all 52 economists surveyed by Bloomberg, while slightly raising its economic growth forecasts for the next few years and reiterating that it will continue to normalize policy based on economic and price conditions.
However, there was disagreement within the policy board, with board member Hajime Takata casting the sole dissenting vote in favor of consecutive rate hikes, reflecting the view among some members that current inflation trends warrant further tightening.
As of the time of writing, the yen continued to weaken, with the dollar trading at 160.46 yen. However, during early US trading on Thursday, July 30, the dollar-yen pair briefly plunged below the 160 level, dropping nearly 500 points in an hour and falling to around 158.00, posting an intraday decline of 3.3%, the largest single-day drop since December 2023.
Hawkish stance further reinforced
Ueda stated that driven by expanded AI-related investment and recent yen depreciation pushing up import costs, inflation is expected to rise significantly above 2% later this fiscal year, with a risk that underlying inflation could overshoot the target. He emphasized that the central bank can adjust policy ahead of fully confirming the inflation trend and should not underestimate the upside risk to inflation.
He noted that AI-related demand is very strong and that related spending is sustainable to some extent.
Ueda also said that monetary policy adjustments take time to transmit to the real economy. Since the last rate hike, market interest rates have risen, and the impact of previous tightening measures still needs to be assessed. He pointed out that the effect of the consumption tax cut on prices remains to be seen, only a small number of companies are affected by higher funding costs, and the overall financial environment remains accommodative.
Furthermore, Ueda said he did not vote at the June policy meeting because he was unable to attend. He stressed that the BOJ has no authority to provide fiscal policy advice to the government.
Yen still driven by interest rate differentials, rate hike expectations yet to materialize
Compared to the BOJ's stance, the US-Japan interest rate differential remains the decisive factor influencing the exchange rate.
Bloomberg data shows that, measured by the 90-day rolling correlation coefficient between the dollar-yen and the 2-year US-Japan overnight index swap spread, the coefficient has risen from about 0.25 in March to 0.44, indicating that the interest rate differential's explanatory power for exchange rate movements continues to strengthen.
Although the BOJ continues to signal a hawkish tilt and explicitly cited exchange rates and Middle East tensions as key variables for future policy, the meeting did not provide a clear signal for an earlier rate hike, leaving the market's assessment of the policy path largely unchanged.
Following the decision, the dollar-yen weakened only slightly, with investors generally betting that the BOJ's next rate hike could come as early as October, though this expectation still depends on further developments in inflation, exchange rates, and external risks.
Meanwhile, the market continues to watch for signs that Japanese authorities may have intervened in the currency market again. Citing informed market sources, reports suggest that Japanese authorities intervened during the New York trading session on Thursday, pushing the yen up 3.3% against the dollar in a single day. Although the Japanese government has not officially confirmed the intervention, Japan's top currency diplomat, Atsushi Mimura, said that support from the United States has gone beyond the moral level, fueling speculation of coordinated intervention.
In the absence of policy support from an earlier rate hike to sustain the yen's recent rebound, the carry trade logic has not fundamentally changed. Short-term interest rate differentials continue to attract capital flows toward dollar-denominated assets, making the yen more dependent on official intervention rather than sustained appreciation driven by narrowing yield spreads.
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