Bank of Japan's Rate Hike Falls Flat, Yen Bullish Bets Face Major Test

According to Zhitong Finance APP, on Monday the Japanese yen stabilized after a sharp decline last week, which had sparked concerns of intervention. This month, major central banks have initiated a wave of interest rate hikes and sent hawkish signals, with investors still assessing the outlook for global interest rates. The Japanese yen stood at 157.04 to the US dollar, having fallen 2% last week. With Japanese markets closed for a three-day holiday, liquidity is sluggish, and traders remain vigilant for possible official intervention.

Last Friday, the Bank of Japan raised interest rates to 1.25%, the highest level in 31 years, but this widely expected hike failed to support the yen. Two dissenting votes and a lack of explicit hawkish guidance disappointed investors. This triggered a sharp drop in the yen, and foreign media subsequently reported that Japanese officials conducted an exchange rate check, which is often seen as a precursor to currency market intervention.

In addition to the Bank of Japan, both the Federal Reserve and the European Central Bank also raised rates this month, warning that, due to the Middle East war that has lasted nearly seven months, further tightening may be necessary to counter inflation.

Fred Neumann, Chief Asia Economist at HSBC, said that since the Federal Reserve sent a hawkish signal with a unanimous decision to raise rates, communication for the Bank of Japan has become even more challenging. He said: "Therefore, the hurdle remains high for the Bank of Japan to convince markets of its hawkish inclination and anchor expectations on the yen. In the coming weeks or even months, investors may again test the Bank of Japan's resolve to continue raising rates and follow the Fed’s tightening pace."

Bullish Yen Bets Face a Test

In early September, traders bet that the Bank of Japan would accelerate rate hikes, and there were initial signs of capital repatriation by Japanese investors, pushing the yen to its strongest level in seven months, though it has since given back some of those gains.

Positioning data show that prior to the Bank of Japan meeting, investor bullish sentiment towards the yen intensified. Weekly data from US regulators show that as of the week ending September 15, speculators increased net long yen positions to $970 million, the largest since July 2025.

Thomas Matthews, Head of Asia-Pacific Markets at Capital Economics, said that although the Bank of Japan raised rates, the market clearly sees the Federal Reserve as the more hawkish of the two, at least relative to expectations earlier in the month. He said: "However, given that the yen has strengthened significantly from previous levels, it may need to weaken further before intervention is back on the agenda."

In July, the yen fell to a forty-year low of 163.99 to the US dollar, after which a rare coordinated intervention between the US and Japan helped boost the yen.

Focus Shifts to Fed Interest Rate Outlook

The US dollar index, which tracks the dollar against six major currencies, remained steady at 100.23. After last week's Federal Reserve rate hike and hints at possible further tightening, the index rose more than 1%.

CME’s FedWatch tool shows that traders currently see a 55% probability of a Fed rate increase at its next meeting in October, up from 42.5% a week ago.

Thomas Simons, Chief US Economist at Jefferies, said: "We believe the midterm elections will not prevent the Federal Reserve from raising rates again in October. Whether there is another hike in December will depend on data and geopolitical developments. Looking ahead to 2027, the rate path will depend on labor market performance. We expect a rate cut is possible in the second half of 2027."

The euro was little changed against the US dollar at 1.1474. Earlier polling suggested the far-right Alternative for Germany (AfD) ranked first in northeast state elections, dealing a blow to Chancellor Friedrich Merz's conservative party.