Yen Slips as Fed Hike Ahead of BOJ Decision Sets Stage for Further Decline

The yen weakened significantly after the Federal Reserve raised interest rates for the first time since 2023, and hinted at additional hikes by mid-next year. This led markets to assume that the US would continue to have a higher interest rate than Japan, even if the Bank of Japan (BOJ) raises its policy rate this week.

The yen's decline was up to 1% overnight, reaching 156.42 per dollar, after an initial surge earlier in the month driven by expectations of a faster BOJ shift toward tighter policy, the reversal of yen-funded carry positions, and chatter that Japanese pension funds might invest more capital in local markets.

Overnight index swaps suggest that a 25-basis-point BOJ move is largely priced in, making Governor Kazuo Ueda's post-decision press conference crucial for investors looking for signals on how quickly and extensively any subsequent tightening could unfold. Board member Hajime Takata has kept open the possibility of a larger-than-usual step or consecutive moves.

Senior rates and FX strategist Rinto Maruyama at SMBC Nikko Securities expects the yen's renewed slide to give the BOJ more reason to stress upside inflation risks, with higher oil prices adding justification for tighter policy. He predicts that Friday's likely increase will lift Japan's policy rate into what estimates define as the neutral range, making it unlikely officials will signal a 50-basis-point step or a sequence of back-to-back hikes.

Aozora Bank Ltd.'s chief market strategist, Akira Moroga, cautions that the BOJ 'may not adopt a stance as hawkish as the Fed's, which could serve as an immediate catalyst for yen weakness.'