Bank of Japan holds rate at 1%, warns it could accelerate hikes as yen intervention talks intensify

The Bank of Japan kept its short-term policy rate at 1% on Friday, sticking with market expectations but stirring a hawkish debate as Governor Kazuo Ueda warned the central bank would not 'fall behind the curve'. The decision came a day after Japanese authorities conducted yen-buying intervention in New York, a move that briefly lifted the currency but did not halt its slide.

Rate decision and dissent

The BOJ board voted 8-1 to hold rates. Hajime Takata, a board member, dissented, calling for a quarter-point increase to 1.25% to counter inflationary risks from external demand shocks. The split was unexpected by analysts and added to the sense that the central bank is leaning toward tighter policy.

Depending on how inflation develops, if the bank judges that monetary conditions are becoming too accommodative, it is entirely possible that it could accelerate the pace of interest rate increases.

Yield curve and inflation outlook

Ueda flagged AI-related demand and currency moves as important risk factors. He said underlying inflation was approaching the 2% target and that upside price risks needed more scrutiny than ever. Board members' inflation forecasts were 'fairly high' and skewed to the upside, he told reporters.

Economists parsed the statement as hawkish. Masato Koike of Sompo Institute Plus said the wording on the 2% target 'represented a step forward' and raised the probability of an October hike over December. Masayuki Nakajima of Mizuho called Ueda's acceleration comment 'the headline quote that markets were waiting for'. Traders lifted the odds of a September quarter-point rise to roughly 40%, up from 30% earlier in the week.

If we fail in our pursuit of stable price growth, we could be forced to raise rates rapidly. That would cause nominal rates to rise significantly and destabilise markets.

Intervention and the US role

Japanese authorities spent an estimated ¥8.45tn ($52.8bn) on Thursday, according to a Mizuho analysis of official data and broker estimates. The yen jumped as much as 3% on the day but gave back about 0.8% by Friday afternoon in Asia, trading around ¥160.69 per dollar.

On Friday the New York Federal Reserve conducted a rate check on dollar-yen at the US Treasury's request, a move that the Financial Times said signalled Washington might intervene to prop up the yen. The yen gained another 1.3% later on Friday, closing near ¥157.28.

Based on the price action, I think Japan must have intervened overnight.

Market reaction

Asian equities staged a blistering rally on Friday. South Korea's KOSPI soared as much as 17%, Taiwan's benchmark gained more than 7%, and Japan's Nikkei 225 rose more than 5%. The KOSPI was still on track for a July loss of nearly 25%, its worst month since 1997. Korean chipmakers Samsung Electronics and SK Hynix jumped nearly 30%, following strong earnings from Amazon and Sony.

What comes next

The BOJ revised up its economic growth outlook while lowering near-term inflation forecasts, but strategists said those revisions were unlikely to derail the expected path of gradual hikes. SMBC chief FX strategist Hirofumi Suzuki noted that growing USD/JPY volatility could prompt markets to price in earlier tightening. Ueda himself said the central bank would debate policy from its next meeting onward with the inflation picture firmly in mind.