Today’s market analysis on behalf of Rania Gule Market Analyst at XS.com

The USD/JPY currency pair dropped by 1.5% yesterday, starting today’s trading session at 149.20, continuing its recent decline after the Bank of Japan announced a surprise interest rate hike yesterday. This is the second interest rate increase by the Bank of Japan since 2007, making Japanese interest rates positive for the first time since September 2010.

I believe the Japanese yen will continue to gain strength against the US dollar, benefiting from the unexpected hawkish announcements by the Bank of Japan. Especially since it is trading at its lowest level after breaking the key support zone at 150.00, with a daily loss of nearly 2%.

On Wednesday, the Bank of Japan raised short-term interest rates by 15 basis points from 0%-0.1% to 0.15%-0.25%. Additionally, the bank plans to reduce its purchases of Japanese government bonds to 3 trillion yen per month starting from the first quarter of 2026. In my view, this change reflects a strategic shift in Japanese monetary policy towards a new phase of financial tightening, a development not seen for over a decade.

In a swift response in financial markets, the Japanese yen rose to 149.78 against the US dollar, its highest level since mid-March. From my perspective, this jump reflects the scale of the market surprise, although some Japanese media had anticipated the decision shortly before its announcement. Furthermore, the Bank of Japan’s plan to halve its monthly bond purchases represents the first serious step towards monetary tightening at a time when most other central banks are moving towards easing, which could support the yen in the medium to long term.

Recently, the world has been experiencing a wave of interest rate hikes by global central banks, particularly during 2022, to combat inflation that surged unexpectedly after the COVID-19 pandemic. However, the Bank of Japan continued its accommodative policy, ignoring these moves even after Japan’s Consumer Price Index rose by 2.8% over the year until June, negatively impacting purchasing power in Japan.

Thus, it was imperative for the Bank of Japan officials to be highly concerned, prompting them to take unexpected steps regarding the recent interest rate hike decision. Therefore, I expect to see a narrowing of the interest rate gap between Japan and other major economic powers worldwide, likely leading to further strength in the yen. This is especially true after Bank of Japan Governor Kazuo Ueda confirmed in a press conference that this step is part of the bank’s strategy to achieve a sustainable 2% inflation target, with a hint that the bank might continue raising interest rates if necessary.

To bolster the yen’s rise, Mitsubishi UFJ Bank announced it will increase its short-term lending rate to 1.625% from 1.475% starting September 2, in line with the Bank of Japan’s rate hike.

On the other hand, the Federal Reserve’s latest decision kept interest rates unchanged during the July meeting in line with market expectations, but Federal Reserve Chairman Jerome Powell again emphasized that US data must provide more confidence in a slowdown of inflation towards its 2% target before the US central bank begins to cut rates. However, expectations are growing for a potential rate cut in September, which adds further pressure on the US dollar and increases the chances of continued selling in the USD/JPY pair.

From my perspective, while the Japanese yen is supported by the Bank of Japan’s hawkish monetary policy, the question remains open on how these movements will evolve amidst the ongoing changes in global monetary policy, especially with growing expectations for a possible shift in the US Federal Reserve’s stance, which could mitigate the impact of Japan’s interest rate hike in the medium term.