Original title: (Japan's Core CPI Exceeds Expectations, Will There Be a Rate Hike in December? Beware of Hot Money Withdrawal from Yen Arbitrage Trading, Repeating the August Stock Market Crash)

Original author: DaFi Weaver, BlockTempo


The Ministry of Internal Affairs and Communications of Japan released the Consumer Price Index (CPI) data for October today, which shows:


· The core CPI (excluding fresh food prices) increased by 2.3% year-on-year, slightly higher than the market expectation of 2.2%, but down from 2.4% in September. This change is mainly attributed to the base effect from last year's government fuel subsidy cuts.


· The year-on-year growth rate of the CPI index excluding fresh food and energy prices is 2.3%, up from 2.1% in September, indicating that demand-driven inflationary pressure continues to exist.


· In addition, the year-on-year growth rate of service prices rose from 1.3% in September to 1.5%, reflecting that companies may pass rising labor costs onto consumers.


These data indicate that Japan's inflation rate remains above the 2% target set by the Bank of Japan, providing a reason for the Bank to raise interest rates next month.


Will Japan raise interest rates next month?


The Bank of Japan will hold a monetary policy meeting on December 18-19 to decide on interest rates. According to a survey by the London Stock Exchange, as of November 22, 55% of economists predict that the Bank of Japan may raise interest rates by 25 basis points at this meeting, increasing the benchmark policy rate from 0.25% to 0.5%.


Marcel Thieliant, head of Asia-Pacific at Capital Economics, also believes that the possibility of the Bank of Japan raising interest rates is quite high, noting that:


‘Potential inflation is rising again, coupled with recent rebounds in consumer spending and the continuous weakening of the yen, all providing ample motivation for the Bank of Japan to raise rates next month.’


Furthermore, according to the latest summary of opinions from the Bank of Japan, if prices and economic performance meet expectations, the Bank may raise the policy interest rate to 1% as early as the second half of the 2025 fiscal year. However, Bank of Japan Governor Kazuo Ueda did not provide clear guidance on the timing of rate hikes, stating that as long as the Japanese economy can steadily achieve price targets driven by strong domestic demand and steadily rising wages, the Bank is ready to raise rates again.


Many economists expect that if the Bank of Japan does not raise interest rates at the next meeting, it may choose to raise the benchmark rate in January next year. Bloomberg economists further predict that the Bank of Japan may raise rates by 25 basis points in January, April, and July next year, forming a tighter monetary policy path.


Yen arbitrage trading may close positions


If the Bank of Japan decides to raise interest rates next month, it will be the second action following the hike in July this year. In September, the Bank of Japan decided to keep interest rates unchanged, considering factors such as global economic uncertainty, financial market volatility, and the strengthening of the yen.


In particular, the volatility in financial markets still lingers. Looking back at early August after the July rate hike, global capital markets suffered severe losses, partly due to the wave of position closures by yen arbitrage traders.


The logic of yen arbitrage trading is to borrow yen at low interest rates in Japan and invest in high-yield assets. However, once Japan raises interest rates:


· Borrowing costs increase, narrowing the profit margins of arbitrage trading.


· At the same time, interest rate hikes usually drive the yen to appreciate, further increasing the exchange rate risk of arbitrage trading.


Under this dual pressure, many arbitrage traders choose to close their positions, leading to a withdrawal of funds that tightens market liquidity and triggers a market crash.


Now, as the Bank of Japan may raise interest rates again next month, the market has begun to reflect this expectation. For example, after today's data was released, the yen appreciated by 0.4% against the US dollar at one point during the trading session. If the rate hike materializes, the yen may strengthen further, necessitating close attention to global capital market movements.


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