BOJ Rate Hike Fails to Satisfy Market Expectations: Yen Rally at Risk

The yen's recent surge has put it at a nearly seven-month high against the dollar, but analysts warn that the Bank of Japan may disappoint markets if it fails to hike interest rates as expected. The BOJ is set to make its policy decision on Friday, and while there are bets that it will double the pace of rate hikes, even this might not be enough to satisfy market expectations.

According to Masafumi Yamamoto, chief currency strategist at Mizuho Securities in Tokyo, 'even if the BOJ hikes this time, it will be hard for the BOJ to be more hawkish than what the market expects.'

Yamamoto notes that the market is pricing in too much, with expectations of a terminal rate above 2 percent. This could damage the Japanese economy and lead to a retreat towards 157 yen per dollar.

The Federal Reserve's decision to hike interest rates next week also threatens to bolster the dollar against the yen. Analysts say that both central banks tightening policy in parallel will keep the yield gap on 10-year bonds at a gaping 200 basis points, one of the fundamental drivers of yen weakness.