Bank of Japan Hawkish Rate Hike to 0.25% - Is the Era of Cheap Yen Officially Over?

The Bank of Japan (BOJ) announced a 15 basis point rate hike on Wednesday, July 31, and plans to gradually reduce bond purchases. As a result, the USD/JPY exchange rate dropped from 153 to around 150, with the Japanese Yen appreciating nearly 2% in just half a day.

Bank of Japan Raises Interest Rates by 15 Basis Points and Plans to Gradually Reduce Bond Purchases

The Bank of Japan (BOJ) announced on Wednesday that it would raise short-term interest rates to 0.25% and gradually decrease the size of bond purchases under its quantitative easing (QE) program. By early 2026, the monthly bond purchases will be reduced to 3 trillion yen, approximately $196.5 billion, half of the current amount.

Prior to this, many Japanese politicians had urged the central bank to tighten its policy further to alleviate the weakness of the yen. The depreciation of the yen has made imported products like food and energy more expensive, leading to public discontent.

Is the Hawkish Rate Hike Politically Motivated?

The Bank of Japan's hawkish move has surprised many. According to interviews with senior foreign exchange traders, there were two prevailing market expectations: one was to raise the benchmark rate by 10 basis points with a minor reduction in bond purchases, and the other was to keep rates unchanged but significantly decrease bond purchases. Some believed that the Bank of Japan would not move towards monetary tightening so quickly.

The Bank of Japan's decision to raise rates by 15 basis points and announce a gradual reduction in bond purchases was more hawkish than expected. Many speculate that there are political considerations at play, as the prolonged significant depreciation of the yen has already sparked public discontent. Prime Minister Fumio Kishida's approval rating in June fell to 16.4%, marking a record low since the Liberal Democratic Party returned to power in 2012.

Strong Rally of the Yen

However, the yen has responded favorably to the Japanese government's expectations. Since the rate hike announcement, the USD/JPY pair has dropped from 153 to around 150, with the yen appreciating nearly 2% in half a day.

End of the Era of Cheap Yen?

Due to Japan's prolonged low-rate policy, investors have used the yen for carry trade, contributing to the long-term depreciation of the yen. The yen began depreciating in 2021, with the USD/JPY rate breaking through 160 in July. In May, Japan intervened in the forex market to prevent further depreciation of the yen.

Carry trade refers to borrowing in low-interest rate countries like Japan and converting it into currencies of higher interest rate countries like the United States to profit from the interest rate differential.

The exchange rate of the yen against the Taiwanese dollar has risen from its low point near 0.2 to 0.22. Is the era of a cheap yen coming to an end?

Senior foreign exchange traders suggest that there are rumors in the market about Japanese retirees actively selling overseas assets and repatriating them to Japan. With the significant rise in the Japanese stock market over the past two years, it would be hard to justify not investing in one's own retirement fund. This repatriation is expected to support the appreciation of the yen.

With the Bank of Japan raising rates while the Federal Reserve in the United States embarks on a rate-cutting cycle, the narrowing of the US-Japan interest rate differential is expected to further boost the yen. However, the interest rate differentials between the two countries are still substantial, so the extent of yen appreciation in the short term may be limited.

Is the era of a cheap yen officially over? It can be said that the historical low levels of the yen have already caught the attention of the Bank of Japan and the government, impacting the livelihood of Japanese citizens. Additionally, with monetary policies in Europe and the United States on the brink of a shift, it may be challenging for the yen to continue depreciating in the long term.

This article does not constitute investment advice. Please DYOR (Do Your Own Research).