As global central banks race to turn hawkish, Bank of Japan risks falling behind as yen remains under pressure

According to Zhihui Finance APP, on Tuesday, the yen came under pressure against the US dollar as traders bet that Japanese policymakers would struggle to keep up with the increasingly hawkish stance of global central banks—a situation expected to maintain a wide gap between Japanese interest rates and those of major economies. As of press time, USD/JPY was quoted at 157.45.

Last Friday, the Bank of Japan raised interest rates by 25 basis points as expected, lifting the benchmark rate to 1.25%, the highest level in 31 years. However, this widely anticipated rate hike failed to support the yen, which instead weakened further. The market believes that comments made by Bank of Japan Governor Kazuo Ueda at the press conference disappointed investors who had been expecting a more hawkish tone.

With Japan on holiday and concerns growing that Japanese authorities might intervene in the forex market, the yen’s decline has been somewhat limited. Earlier reports suggested that Japanese officials checked the USD/JPY exchange rate last Friday—a move often seen as a precursor to possible government intervention in the foreign exchange market.

Except for the rebound following reports of FX rate checks by Japan, the yen has been under pressure since the Bank of Japan’s rate hike on Friday. When asked about the possibility of a 50 basis point hike or consecutive rate hikes, Kazuo Ueda said at the press conference: "It depends on how price trends evolve. There are many possibilities, and we shouldn't rule out any options. We are at a stage where we need to carefully examine various data. However, this does not mean action can be slow. We will analyze the data carefully and act in a timely manner when necessary." He added: "As for the pace of future rate hikes, we have no preset scenarios, such as once every three months. We will decide at each policy meeting how best to ensure that underlying inflation remains stable at 2%."

Kazuo Ueda also stated: "As we raise rates, financial conditions are becoming less accommodative… It’s important to avoid tightening financial conditions too much or triggering a sharp adjustment in asset prices due to aggressive rate hikes."

In addition to Kazuo Ueda's less hawkish comments, two members of the Bank of Japan's monetary policy committee voted against the rate hike last Friday, raising concerns that the central bank remains "not hawkish enough." Of the nine policy members, Unichiro Asada and Ayano Sato cast dissenting votes. Asada cited that the CPI excluding fresh food is rising less than 2%, and "the economic situation may not be strong"; Sato argued that the economic and price situations have not significantly accelerated, so "a rate hike at this time is not appropriate."

This contrasts with the US Federal Reserve, which also raised rates last week, and differs from the stances of most major global central banks. After consecutive hawkish signals, markets currently expect further rate hikes from these central banks later this year.

Current market pricing indicates about a 30% chance that the Bank of Japan will raise its benchmark short-term interest rate to 1.5% by October. Meanwhile, markets indicate a 55% probability that the US Federal Reserve will deliver another 25 basis point hike in October, raising the federal funds target range to 4% to 4.25%.

Carlos Casanova, Senior Economist for Asia at UBS Private Banking, stated in a client report: "Unless the Bank of Japan tightens policy faster than the Federal Reserve, the approximately 275 basis point rate differential between the US and Japan will continue to support yen-funded carry trades. We expect USD/JPY to rise to 160 by year-end, then moderate to 156 by mid-2027."

In addition to the yen, the New Zealand dollar is also expected to remain under pressure. With New Zealand’s interest rate at only 2.75%, significantly lower than other major economies, the New Zealand dollar has been hovering near several-month lows, with NZD/USD at 0.5708. In addition, Reserve Bank of Australia Governor Michele Bullock is expected to deliver a hawkish signal in a fireside chat later Tuesday. Markets currently estimate a 90% probability of another rate hike by the Reserve Bank of Australia next week, which would be the fourth hike this year.

Analysts at ANZ said in a report: "As high-yielding currencies benefit from more attractive carry trades, the price action of the NZD appears weak. Even if markets expect the Reserve Bank of New Zealand to hike around five more times, it’s still insufficient for the official cash rate (OCR) to approach the US federal funds rate or the Reserve Bank of Australia’s cash rate, both of which are expected to rise further."