The Yen has sold-off after the Bank of Japan (BoJ) ended eight years of negative interest rates and made its first interest rate hike since 2007. On Tuesday, the BoJ raised interest rates from minus 0.1% to a range between 0.0% and 0.1%.
Normally such a move would be expected to strengthen a currency, since higher interest rates attract greater inflows of foreign capital, however, in the case of the Yen the opposite happened.
One reason given for the Yen’s counter-intuitive response is that despite the hike, interest rates in Japan are still so low relative to other countries that JPY remains a favored “funding currency” by international investors. This means they borrow in the Yen (because of the low interest repayments) in order to buy other currencies which pay higher interest rate returns.
“The broad-based view is that the gulf in interest rates between Japan and many other central banks in the G10 space means that the Yen will still be used as a funding currency in a low-volatility world.” Say analysts at ING.
A further reason for the Yen weakness following the BoJ decision is the view that the interest rate hike was just a “one off” rather than the start of the hiking cycle.
“While the BoJ may be able to hike rates again this year, this prospect currently remains highly uncertain.” Say analysts at Rabobank.
Much depends on whether wage gains negotiated by Japanese workers’ unions percolate out to the wider working population, since only 30% of workers belong to unions.
“Assuming the strong pay deals awarded to unionised workers spread out to the 70% of employees who are not in a union, Japan’s real wage growth could soon be turning higher. Policymakers will be hoping that this boosts consumption which in turn supports corporate profitability. This would indicate that the BoJ’s virtuous cycle is complete.” Says Rabobank.
USD/JPY rally put down to USD strength
The US Dollar is gaining ground across the board on the back of expectations the Federal Reserve (Fed) will keep interest rates higher for longer in the US, due to stubbornly high inflation. This too is a factor in the USD/JPY’s gains.
There is even speculation that the Fed will reduce the number of rate cuts it expects to make in its Summary of Economic Projections (SEP), a set of forecasts which it publishes at the same time as it announces its monetary policy decision.
In the December SEP the Fed forecast three 0.25% rate hikes in 2024, but analysts at Nordea Bank and Macquarie, to name two, are expecting that to be reduced to two cuts in the March SEP
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