The Bank of Japan (BOJ) increased its policy interest rate to 1.25% on Friday, marking a 31-year high. This 25 basis point hike, following a previous increase three months prior, was largely expected by the market. However, the yen weakened significantly, falling as much as 0.7% against the dollar to 157.09, and was 0.7% weaker against the euro at 180.21 yen. This counterintuitive market reaction, where interest rate hikes typically strengthen a currency, was attributed to the divided decision within the BOJ board and a lack of a hawkish outlook from Governor Kazuo Ueda.
The policy board's decision to raise rates was not unanimous, with a 7-2 vote. Dissenting members Toichiro Asada and Ayano Sato argued that the economic situation and inflation, which stood at 1.7% core inflation in August, did not warrant a hike. This split decision, alongside the absence of updated economic forecasts and a lack of a more hawkish tone from the BOJ, led analysts to believe that further aggressive tightening might not be immediate. Experts like Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corporation, highlighted the surprise of the two dissenting votes as a key factor.
Market participants had been looking for stronger signals that the BOJ would continue normalizing its policy, but the communication fell short of these expectations. The yen's softness also followed data showing Japan's core inflation holding steady near the central bank's 2% target. While another rate hike is anticipated, possibly in December, the market is now debating the ultimate peak of rates, with some economists, like Sam Jochim of EFG International, projecting a terminal rate between 1.75% and 2% by 2027. The BOJ stated it would continue to raise rates "as appropriate," while also acknowledging that growth might decelerate due to high oil prices.
