Japan is entering a decisive week for monetary policy and currency markets, with the Bank of Japan preparing to raise interest rates to the highest level in 31 years, in conjunction with the government confirming continued close coordination with the United States to ensure the stability of the exchange market, after a joint intervention that helped the yen recover more than 6 percent of its value since late July.
The moves reflect a Japanese effort to manage a careful equation to prevent a weak yen from reigniting inflation, without allowing the currency's rise or excessive monetary policy tightening to harm the economic recovery.
Finance Minister Satsuki Katayama said that the government will continue close communication with Washington to ensure orderly movements in the currency market, stressing that Tokyo’s position has not changed since the coordinated Japanese-American intervention and the joint statement that followed it.
Her statements gain importance after US Treasury Secretary Scott Besent's warnings to investors who bet against the yen. Katayama described his statements as a direct expression of his vision for the market, noting his previous background in the hedge fund sector.
• Raising is almost settled
In parallel with coordination on the currency, the Bank of Japan, according to informed sources who spoke to Reuters, is preparing to raise the interest rate by 25 basis points during its meeting on September 17 and 18, to reach 1.25 percent, a level that Japan has not seen in 31 years.
The bank had raised the interest rate to 1 percent in June, and a new increase after only three months would confirm the acceleration of the exit from ultra-easy monetary policy contracts.
Circles within the bank believe that conditions have become favorable for this step, in light of a moderate economic recovery and expanding price pressures. Even at 1.25 percent, the bank believes that financial conditions will remain relatively accommodative.
The markets are almost completely pricing in the September increase, while analysts polled by Reuters expect interest rates to reach 1.5 percent by the end of next March, then 1.75 percent in the second quarter of 2027.
Despite speculation that it could surprise markets with an increase of 50 basis points, the bank's estimates indicate that there is no imminent jump in wages and prices that would require a move of this size.
Bank Board member Kazuyuki Masu confirmed that core inflation is about to reach 2 percent, but it does not show signs of sharply exceeding this level.
• Oil complicates calculations
The bank's equation is further complicated by two opposite trends in prices. On the one hand, the yen has risen by more than 6 percent since the Japanese-American intervention in late July, which is supposed to reduce the cost of imports and ease inflation.
But on the other hand, Brent crude oil exceeded $100 per barrel, threatening to return energy cost pressures to the Japanese economy, which is highly dependent on imports.
Wholesale price data came to increase concern, after annual wholesale price inflation reached 7.6 percent during August, an indication that companies are facing increasing pressure that may gradually be transmitted to the consumer.
The Bank of Japan had forecast in July that core consumer inflation would reach 2.5 percent during the fiscal year ending in March 2027, then 2.4 percent the following year, before slowing to 2 percent.
• Where does the interest reach?
But the bigger issue for investors is no longer the September increase itself, but rather the level at which the tightening cycle will stop.
According to the sources, the Bank of Japan does not have a prior vision for the final interest rate, as this will be determined based on the impact of previous increases in the economy and the extent of companies’ ability to pass on higher input costs to families. There is also no consensus within the bank's nine-member board about the appropriate speed of tightening. Members who are more inclined to raise rates believe that core inflation has already almost reached the target level, while more cautious members call for avoiding rapid tightening that might weaken demand.
That's why Governor Kazuo Ueda is likely, following the next meeting, to avoid committing to a specific timetable for subsequent increases. But he may repeat his previous position that the bank is ready to accelerate the pace of rate hikes if financial conditions appear to remain too accommodating.
After the September meeting, the bank will hold further meetings in October, December, and then January, giving it several opportunities to assess the impact of inflation, energy, and the yen before taking the next step.
• The yen is at the heart of politics
Developments reveal that the yen has become the link between Japanese monetary policy and coordination with Washington. The fall of the currency increases import prices and fuels inflation, while its rapid rise reduces the profits of exporters and may put pressure on the economy.
US support for the stability of the yen gives Tokyo more space to normalize monetary policy, while coordination between the two countries reduces the risk that speculators will quickly return to building huge bets on the weakness of the currency. All eyes are therefore on the Bank of Japan's meeting next week, not only to see whether it will raise interest rates, but also to anticipate how quickly it wants to return the cost of money to more normal levels.
Between a stronger yen, oil exceeding $100, and wholesale price inflation at 7.6 percent, the September increase appears to be an almost settled step, but the path that follows will be the most difficult test for the Japanese economy and markets.
Japan's Nikkei index fell on Friday, amid renewed concerns about raising US interest rates and a sharp rise in oil prices that fueled concerns about inflation. The Nikkei index fell by 1.93 percent to close at 64,011.34 points, recording a weekly decline of 0.4 percent.
The index had previously fallen by 3.16 percent, while the broader Topix index fell by 0.65 percent to reach 4,028.30 points. US stocks fell during last night's trading, as rising Treasury bond yields and August producer price data strengthened expectations that the Federal Reserve (the US central bank) would raise interest rates. Federal Reserve Chairman Kevin Warsh has signaled a shift in policy away from “forward guidance,” keeping investors on their toes for upcoming inflation numbers. Meanwhile, geopolitical tensions continued as the standoff between the United States and Iran continued to negatively impact energy markets.
“With Fed Chair Warsh signaling a focus on curbing inflation, the wait-and-see approach in the Japanese stock market is likely to strengthen,” Takuma Ikemoto, a market analyst at Tokai Tokyo Intelligence Lab, said in a note.
Shares of the technology sector and companies related to artificial intelligence led the decline in the Nikkei index. Where 95 companies recorded an increase in the index, compared to a decline of 128 companies, while two companies remained unchanged.
The largest losing companies were “Resonak Holding,” which fell by 10.68 percent, followed by “Kioxia Holding,” with a decrease of 6.99 percent, then “Tuban Holding,” which lost 6.95 percent of its value. The biggest gainers were “L-Y”, which rose by 3.44 percent, followed by “Kawasaki Kisen Kaisha”, which rose by 2.94 percent, then “Dai-ichi Life Holding”, which rose by 2.73 percent.
*High returns
For its part, Japanese government bond yields rose across various maturities on Friday, in light of selling in global debt markets and increasing expectations that central banks will raise interest rates.
The yield on Japan's benchmark 10-year government bond rose 6 basis points to 2.970 percent. Yields move in the opposite direction to bond prices.
Global bond markets set the general trend, as US Treasury bond yields rose sharply overnight, driven by stronger-than-expected producer price data and higher oil prices, which reinforced expectations that the Federal Reserve would raise interest rates next week.
Takayuki Miyajima, chief economist at Sony Financial Group, said in a note: “High crude oil prices and the weakness of the US Treasury bond market are likely to act as catalysts for selling operations, and upward pressures on interest rates in the domestic bond market are expected to intensify... In the period leading up to the meetings of the Bank of Japan and the Federal Reserve next week, the market is going through a phase of careful assessment of the direction of monetary policy.”
Data released on Friday showed that wholesale inflation in Japan remained high in August, highlighting increasing price pressures that strengthen the Bank of Japan's justification for raising interest rates.
The yield on 40-year Japanese government bonds - Japan's longest-term bond - rose by 3.5 basis points to 4.110 percent, while the 20-year yield rose by 5.5 basis points to 3.805 percent, and the 30-year yield increased by 4.5 basis points to 4.050 percent.
At the short-term end of the yield curve, the yield on two-year bonds - which are most sensitive to interest rates set by the Bank of Japan - rose by 1 basis point to 1.830 percent, while the five-year yield rose by 3 basis points to 2.250 percent.
