Yen Weakness Persists Despite BoJ Hike

The Bank of Japan's interest rate hike to 1.25%, the highest level since 1995, failed to support the yen as expected. Instead, it weakened further against the US dollar.

This unexpected reaction is attributed to a dovish signal from the BoJ regarding its future path. The market read the vote breakdown of 7-2 in favor of the hike, but with two dissenting members known for their favorability towards loose monetary and fiscal policy.

The Fed's hawkish tone, communicated through Kevin Warsh, has driven US bond yields towards 5% and reinforced the rate divergence between the US and Japan. This favors the dollar in carry trade, where borrowing cheap yen is attractive to invest in higher-yielding assets abroad.

BoJ forecasts indicate core inflation will accelerate above 2% due to pass-through of earlier oil price increases, rising durable goods prices from yen depreciation, and increasing wages and prices. The bank expects inflation to return to the 2% target only later in the forecast horizon.