Bank of Japan Governor Kazuo Ueda stated in an interview last Saturday that if economic performance meets expectations, the Bank of Japan will proceed with its third rate hike this year. The market expects the Federal Reserve to continue lowering rates this month, and the ongoing narrowing of the U.S.-Japan interest rate differential may help the yen continue to rise.

Will the Bank of Japan raise rates for the third time this year?

Since Kazuo Ueda took office in April 2023, the first full year has made 2024 a milestone year. He ended the central bank's massive monetary easing program in March and implemented the first rate hike in 17 years. Ueda raised rates again in July by 15 basis points, an action that surprised many hawks and led to yen arbitrage unwinding, triggering a global stock market correction.

The next rate hike will raise the Bank of Japan's policy interest rate from 0.25% to 0.5%, the highest level since 2008, marking a significant change after maintaining a negative interest rate of -0.1 for a long time.

According to Bloomberg, in a media interview published on Saturday, Ueda noted that he is closely monitoring wage negotiations and any potential risks to the U.S. economy, as Japanese authorities seek to achieve a soft landing during a political transition period. The strong wage growth achieved this spring was the impetus for the central bank's decision to begin reducing stimulus measures in March.

The U.S.-Japan interest rate differential will continue to narrow.

The interest rate differential between the United States and Japan may narrow this month due to the rate decision measures from both sides. As of Monday, traders estimated that the likelihood of the Federal Reserve lowering interest rates is about 67%, while the probability of the Bank of Japan raising rates is around 61%, doubling from a month ago.

Ko Nakayama, chief economist at Okayama Securities and a former Bank of Japan official, believes that the next rate hike could happen in December. The Bank of Japan has indicated that it will act if the economy meets official forecasts. There is increasing evidence supporting this. However, if the Federal Reserve takes action and the Bank of Japan does not, it may highlight the cautious stance of the Bank of Japan and weaken the yen, potentially becoming a source of turmoil and undermining financial market stability.

Some economists believe that the political factors stemming from the current ruling coalition losing its majority may delay the Bank of Japan's rate hike actions until January.

The Bank of Japan will announce its interest rate decision on December 19, while the Federal Reserve will conclude its FOMC meeting a day earlier on December 18.

Is the era of a cheap yen coming to an end?

Japan, due to its long-standing low rate policy, has been used by investors as a tool for carry trade, which is also one of the main reasons for the long-term depreciation of the yen. The yen began to depreciate in 2021, with the USD/JPY exchange rate breaking above 160 several times in July this year. Japan intervened in the foreign exchange market in May to prevent further depreciation of the yen.

Note: Carry trade refers to borrowing in a low-interest country (like Japan) and exchanging it for currency in a higher interest country (such as the United States) to earn the interest differential.

The Nikkei 225 index has risen nearly 20% this year, becoming one of the best-performing major indices globally. The return of capital, along with the narrowing of the U.S.-Japan interest rate differential, will help the yen appreciate, although the differential remains large, limiting the extent of the rise in the short term.

Is the era of a cheap yen officially over? It can only be said that the previously historically low yen has drawn the attention of the Bank of Japan and the government, affecting the livelihoods of the Japanese people. It is likely that the yen will struggle to continue depreciating in the long term.

(This article is not investment advice, please DYOR)

This article: Will the Bank of Japan raise rates for the third time in December? Will the yen rise again? Originally appeared in Chain News ABMedia.