BOJ Jumps into Hawkish Mode with 31-Year High Interest Rate

The Bank of Japan (BOJ) has raised its benchmark interest rate to 1.25%, marking a 31-year high, following the Federal Reserve's decision to hike its own target range two days earlier.

This move is aimed at tackling inflation, which hit 1.9% in August, exceeding the BOJ's 2% target. The bank's policy rate was raised by a quarter point, from 1.0% to 1.25%, with seven board members voting in favor and two dissenting.

The yen did not rally following the decision, instead weakening 0.45% against the dollar. This is significant because it makes carry trades harder to unwind cleanly, as rates rise and borrowing costs increase without a corresponding strengthening of the currency.

The BOJ's move comes on the heels of the Federal Reserve's hike, which saw its target range raised to 3.75%-4%. The two decisions mark a rare moment where the world's two largest economies are tightening monetary policy in tandem, both targeting inflation that has been pushed higher by oil price shocks.

The yen carry trade, which involves borrowing yen at low rates and converting it into dollars to invest in higher-yielding assets, is now under pressure. The two-year government bond yield in Japan has climbed to 1.746%, a 31-year high, making the cost of borrowing more expensive.