Markets eye BoJ meeting as yen nears 40-year lows

The Bank of Japan will meet on July 31 to consider changes to its benchmark policy rate as the yen trades near 40-year lows against the US dollar and USD/JPY approaches 164. The policy rate is already 1.0%, its highest level since September 1995.

USD/JPY has built on last week’s gains, remaining above the 160 level and testing multi-decade highs. Market-implied probabilities and prediction markets put the odds of a rate hold at roughly the high 90s percent after the BoJ raised rates in June.

In a summary of the June meeting, the central bank said it judged that “given that underlying CPI inflation has been approaching 2% and financial conditions have been accommodative, it is appropriate for the Bank to continue to raise the policy interest rate and adjust the degree of monetary accommodation, in response to developments in economic activity and prices as well as financial conditions.” Policy officials will weigh recent price trends, growth and market stability ahead of the July 31 decision.

The BoJ has warned that a weaker yen can affect inflation and household spending. In its Outlook for Economic and Prices, the bank noted that with firms shifting toward higher wages and prices, exchange rate moves are more likely than in the past to affect prices and could influence underlying CPI inflation through changes in inflation expectations.

The yen’s role as a global funding currency stems from decades of low interest rates and Japan’s historical trade and current-account surpluses. Since Japanese inflation picked up after 2022, that role has raised the risk that leveraged yen carry trades could unwind quickly and reduce liquidity across markets.

Interventions and rapid shifts in yen positions coincided with a marked unwind of carry trades in August 2024, a period that saw sharp declines in major cryptocurrencies. Market participants say a repeat could follow any unexpected change in policy or rate expectations.

Analyst Ricky Ho wrote on social media that the carry trade “only works if two conditions remain intact. Japanese interest rates remain exceptionally low. The yen remains broadly stable or continues depreciating,” and warned that carry-trade reversals are “rarely gradual” because of high leverage. He added that the direction of BoJ policy has fundamentally changed and investors are monitoring timing of future hikes.

Policymakers will monitor exchange rates, wage and price behaviour, and financial conditions when deciding next steps. For now, markets are positioned for a rate hold on July 31 while watching for any new guidance on the BoJ’s path for rates and the potential for intervention in currency markets.