Alex Holmes of EIU discusses the Bank of Japan's latest decision to hike its policy rates, and why it still led to the yen weakening further. He discusses the central bank's delicate balancing act, having to manage inflation, domestic demand as well as growth.

Tokyo

The Japanese yen weakened after the Bank of Japan implemented a well-telegraphed rate hike, as markets had largely priced in the decision. Analysts noted that the central bank's cautious communication and lack of clear forward guidance left investors uncertain about the future pace of monetary policy normalization.

Additional factors influencing the yen's decline included concerns over Japan's fiscal stimulus, ongoing trade tensions with China, and shifts in US monetary policy expectations. Despite some signs of economic resilience, high inflation and weak domestic demand continue to pose challenges for Japan's economic recovery.

Why did the yen weaken following the Bank of Japan's rate hike?

I think this decision was very well communicated in advance, so it was much in the price everyone was expecting by early December or late November for this decision to go the way that it did. The big question really ahead is how fast will the pace of normalisation go, and that will depend a lot on the incoming data, it will depend how much inflation remains sticky, whether it continues to become more broad-based as we've seen in recent months, and it will depend on the wage negotiations that will come probably in early March. The question is, will rates go to 1%, 1.2%, 5% or even further in 2026? It's interesting you mentioned that the decision itself was well communicated, but then you have a number of people in the markets also saying that the outlook now was actually quite vague. How tricky or difficult is it for the Bank of Japan to not just communicate but get some of these decisions right, because while the economy is showing signs of just stabilising at the moment, some might argue that the patient is still in a bit of a fragile state at the moment. Would you agree? Yeah, definitely. Any central banker is not going to want to tie their hands and give forward guidance out over the coming quarters. They just want to communicate changes in the near term, maybe a month ahead. The Bank of Japan definitely is in wait-and-see mode, it's going to watch the data, it's going to see what's happening. As you mentioned, the economy is not out of the woods yet. There is the fact that Donald Trump's tariffs are still coming into the picture and having an effect on exporters, and the trade front loading that we saw supporting growth in 2025 is turning into a bit of a tailwind already and might turn into a bit more of a major one in early 2026. So yes, if I were a central banker, I would want to keep my cards close to my chest. Okay, so attempting to revive the patient, so to speak. Alex, just on the market reaction, why do you think the yen moved in the, quote-unquote, wrong direction here off the back of this move? And what do you think is driving JGP yields higher right now? Yes, so I think the immediate move on the day was probably due to markets kind of adjusting their expectations based on what was said at the policy meeting. So maybe they were looking for a bit more of a hawkish forward guidance over what the neutral rate might be. I would be surprised if the central bank governor were to give any kind of estimate of that, but perhaps markets were looking for a bit more of a steer. So the yen might have weakened on that basis. More generally, why is the yen weakening whilst the Bank of Japan is normalising policy, raising rates? You know, there's a good chart that analysts like myself and many others have drawn of the yield differential with the US, and usually the yen moves very closely with that. But the two series have uncoupled recently, and that's because of a couple of other factors. It's because of fiscal stimulus and the fiscal position, which is making investors a little bit nervier about the fiscal position of Japan, but it's also due to the trade and economic spat with China, which is raising the risk premium on Japanese assets. Interesting as well. Do you think market investors are currently buying what Sane Takeichi is selling? Because as you say, a lot of the reaction function in the yen has been off the back of the fiscal spending plans that I think the market is ultimately still trying to digest right now. That's true. We've also got to look at the other side of the coin of the Japan-US rate differential. So the US outlook has changed as well. Many people are looking for extended pause in Fed cuts in the first half of 2026. So a more hawkish Fed outlook is also kind of the other side of the coin to this. Yes. But again, going back to, I guess, the fragility of this economy, because again, the growth, while there is signs of growth in the Japanese economy, nothing really to write home about. How important is it for the BOJ to get their timing right? Because again, if they hike too quickly, that could actually stymie growth. But if they hike too sluggishly again, that normalization could have certain distortions that might get introduced into the financial markets and whatnot. How can you describe perhaps, if at all, if it is indeed true, how difficult or complicated is it for the timing and the decision to be gotten right by the BOJ? Yes, I think you've hit the conundrum, kind of the nail on the head there. A lot of the problem with growth in recent times has been the weakness of domestic demand. And a lot of that has been due to the fact that inflation has been high and cost of living pressures have been high. And that has constrained consumer spending. Now, why is inflation high? A lot of it is due to the import channel and because of weak yen. And so yen weakness is brought about by slowing the pace of policy normalization. So there's almost kind of a break in the link between the usual kind of, if you keep policy looser, it'll be good for the economy. If you tighten it, it will slow down growth. So it's a tricky situation for the Bank of Japan, and that's why it is such a balancing gap for them. There are some more factors that are coming in now that are driving the economy other than just what's happening to inflation. Of course, I mentioned earlier fiscal stimulus. So that should help actually create another driver for growth. And we are seeing actually more resilient consumer spending. And the Tankan survey for December was actually quite positive on the industry side as well.

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