Yen's Rally Hinges on Bank of Japan Rate Decision Amid Fed Tightening

The yen's recent surge against the dollar may be short-lived as market expectations shift towards a more hawkish monetary policy decision by the Bank of Japan. The yen has risen by 5% against the dollar since the beginning of September, reaching a nearly seven-month high of 152.89 yen per dollar last week.

Market analysts believe that the Bank of Japan will accelerate its rate hikes to once per quarter, with some predicting a terminal rate above 2% in about a year. However, Masafumi Yamamoto, chief currency strategist at Mizuho Securities, warns that even a rate hike may be insufficiently hawkish for market expectations.

The yen's strengthening could also be influenced by the expected tightening of monetary policy by the US Federal Reserve, which is set to raise its rate on Wednesday and potentially do so once per quarter over the next 12 months. This could maintain the yield gap between 10-year US and Japanese government bonds at around 200 basis points.

Additionally, speculation about capital repatriation from Japan's Government Pension Investment Fund has also contributed to the yen's strengthening. However, analysts consider expectations of large-scale capital repatriation exaggerated, as GPIF management rules require minimizing market impact through gradual changes in asset allocation.