Fitch Solutions’ BMI analysts recently noted that the Bank of Japan (BOJ) is expected to proceed cautiously with interest rate hikes to prevent a rapid appreciation of the yen following the recent turbulence in global markets.
They anticipate a modest 25 bps increase to 0.50% this year, a downgrade from the initial projection of 50 bps.
The BOJ’s previous interest rate hikes led to the unwinding of the yen carry trade, triggering a significant sell-off in global markets, as observed last Monday when Japan’s Nikkei 225 plummeted by 12%, experiencing its worst performance since 1987. Despite this, the benchmark index has since rebounded significantly and surpassed its pre-turmoil levels.
Carry trades involve borrowing in a currency with low interest rates, like the Japanese yen, to invest in higher-yielding assets. While this strategy has gained popularity in recent years, a weakened yen has bolstered Japan’s stock market, and sudden strengthening could elevate market volatility.
In response to the market instability, BOJ’s Deputy Governor Uchida Shinichi confirmed that the bank would refrain from raising policy rates during this period of uncertainty.
Looking ahead to 2025, BMI projects that BOJ’s rate hikes will be limited to 25 bps, influenced by the Federal Reserve’s expected 200 bps rate cut to reach 3% next year. This forecast suggests that interest rates will conclude 2025 at 0.75%, lower than BOJ’s target terminal rate of 1.00%, which could prevent a substantial yen appreciation.
