The market is pricing in an 84% probability of a rate hike by the Bank of Japan in September.
The derivatives market and prediction platforms have radically revised expectations for Japan's monetary policy. In just two weeks, the probability of a rate hike by the Bank of Japan at the September meeting has surged from 22% to 84%. This is a signal that cannot be ignored: traders and investors are increasingly pricing in a tightening of the regulator's policy.
The reason for such a sharp reversal is the weakening effect of currency interventions by Japanese authorities. The yen, which had previously shown a confident recovery, has come under pressure again. This week, the USD/JPY exchange rate rose by about 1%, reaching 159.43. This is the worst weekly result for the Japanese currency since May of this year.
The yen loses its gains
After the coordinated currency intervention in late July and early August, when the exchange rate pulled back from levels around 164 per dollar, the yen managed to recover a significant portion of its losses. However, the currency has now already given back about half of that gain. History repeats itself: after the April intervention, the yen also slid back to multi-year lows over several months.
It is telling that even former senior officials responsible for currency policy acknowledge the limitations of interventions. They emphasize that authorities are ready to deploy reserves at any moment, but more decisive steps from the central bank are needed for sustainable support of the currency. The market seems to have picked up on this signal: bets are now being placed not on new interventions, but on an actual interest rate hike.
Betting on policy tightening
The link between yen weakness and rate expectations is obvious. Market participants are increasingly leaning toward the view that the Bank of Japan will be forced to raise rates by 25 basis points as early as September. Inflation in the country is approaching the target level, and the regulator will likely want to cement that success while also supporting the national currency.
However, the opposite scenario also carries serious risks. If the Bank of Japan leaves rates unchanged, the market could react with sharp disappointment, and the yen would once again head toward 160 per dollar. All attention is now focused on the central bank's actions, rather than on targeted currency interventions, which, as practice shows, provide only a short-term effect.
My view: the market may be too optimistic in its expectations. The Bank of Japan has historically acted with extreme caution and is unlikely to raise rates unless it sees sustained growth in inflation and wages. Nevertheless, the current dynamics of the yen and market pressure on the regulator could force it to act faster than planned. Investors should closely monitor officials' rhetoric in the coming weeks.