Bank of Japan is hostage to exchange rates: July rate hike most likely, but yen depreciation may rewrite the timetable

Exchange rate trends are becoming a key variable influencing the Bank of Japan’s policy decisions. According to the latest news, a Bloomberg survey shows that economists have diverging expectations regarding the timing of the next rate hike by the central bank, but more importantly, the continued depreciation of the yen is fueling market expectations of an earlier rate increase. This reflects the real dilemma faced by the central bank: stabilizing the exchange rate requires raising interest rates, but rate hikes will increase already high debt costs.

Divergence and Consensus in Market Expectations

Based on Bloomberg’s latest survey of 52 economists, there is a clear divergence in market expectations regarding the timing of the Bank of Japan’s next rate hike:

This distribution is quite interesting. Although July is the most mainstream expectation, support is only 48%, indicating that the market’s certainty about the timing is not high. This highlights a core issue: the central bank’s policy options are under multiple pressures, and the traditional “rate hike every six months” rhythm may be disrupted.

Exchange Rate Pressure as a Key Policy Variable

The most noteworthy detail in the survey is that three-quarters of respondents believe that the yen’s weakness is increasing the risk of the Bank of Japan raising rates earlier than planned. This is not mere speculation but a realistic judgment.

Currently, USD/JPY hovers around 158.5, close to the multi-decade low reached in July 2024. More critically, Sumitomo Mitsui Trust Bank economist Junki Iwabashi pointed out a critical threshold: if the USD/JPY falls below 160, the timing of rate hikes could be significantly advanced.

This means that the exchange rate is no longer just one of the indicators observed by the central bank but is becoming a direct trigger for policy adjustments.

The Real Dilemma Facing the Central Bank

Behind this pressure lies a dilemma faced by the Bank of Japan:

The necessity of stabilizing the exchange rate

The ongoing depreciation of the yen not only affects the exchange rate but also raises inflation expectations. According to relevant information, Japan’s government debt has already reached 240%-260% of GDP, meaning that a weaker yen leading to higher import prices will directly push up overall inflation, increasing the policy pressure on the central bank.

The cost of rate hikes

However, raising interest rates also faces difficulties. Japan’s high debt burden means that for every 1 percentage point increase in interest rates, government interest payments will rise significantly. According to the survey, economists’ median forecast for the terminal rate in this cycle has been raised to 1.5%—the highest level since the end of 2023. Moving from 0.75% to 1.5%, the increase in debt servicing costs is substantial.

Critical Conditions for Triggering an Early Rate Hike

Another implicit message from this survey is that the central bank may already be considering different policy paths. Economists generally expect the pace of future rate hikes to remain at every six months, but this assumes that the exchange rate remains relatively stable.

Once USD/JPY falls below 160, this assumption could be broken. Based on current information, this critical point is quite close to the current 158.5, requiring only a further depreciation of about 1.5 points. Since July 2024, the yen has experienced prolonged depreciation pressure, making the likelihood of triggering this critical point quite high.

Key Focus Moving Forward

Next week’s (January 22-23) policy meeting will be an important observation window. Most respondents in the survey believe that the key focus will be on the Bank of Japan’s updated quarterly economic outlook report, which for the first time incorporates the economic stimulus plan introduced by Prime Minister Yoshihide Suga’s government. The wording of this report, especially regarding the exchange rate and inflation, could send important signals about the future pace of rate hikes.

If the central bank’s language on exchange rate risks becomes more cautious, it may imply an increased likelihood of an early rate hike.

Summary

The Bank of Japan is gradually being pushed toward an earlier rate hike by exchange rate pressures. On the surface, July remains the most mainstream expectation, but this outlook is being eroded by the yen’s depreciation. The critical threshold of USD/JPY 160 has effectively become an invisible trigger for the central bank’s policy decisions.

For the market, attention should not only be on whether the BOJ will raise rates but also on how the exchange rate trend influences this timetable. Against the backdrop of tightening global liquidity and pressure on Japan’s bond market, the central bank’s policy space is gradually shrinking. Next week’s policy statement and the subsequent USD/JPY movements will be key signals in assessing whether the BOJ will be forced to act prematurely.