Yen weakness forces Bank of Japan to act! Former committee member: Rate hike likely in September, another possible in January next year

According to Zhitong Finance APP, former Bank of Japan Policy Board member Seiji Adachi stated that there is a high possibility that the Bank of Japan will raise interest rates next month, thus validating widespread market expectations, with another potential rate hike as early as January next year. In an interview, Seiji Adachi noted that despite joint intervention by the U.S. and Japan, the yen remains weak. If the Bank of Japan decides to maintain its current policy stance, it could trigger another wave of yen selling, thereby increasing the risk of import-driven inflation. He said: "The Bank of Japan has basically been forced into a corner. The market has almost fully priced in a rate hike. If the BOJ does not raise rates, the yen could weaken sharply again."

As of press time, the USD/JPY exchange rate was 1 USD to 159.10 yen, not far from the psychologically important threshold of 1 USD to 160 yen. At the same time, traders estimate there is about an 80% probability that the Bank of Japan will raise rates in its next policy decision announcement on September 18.

U.S. Treasury Secretary Wally Adeyemo previously pointed out that monetary policy actions should follow foreign exchange intervention, and expressed hope that Bank of Japan Governor Kazuo Ueda would raise interest rates. Adeyemo's remarks gave Ueda "a good opportunity" to hike rates, as it makes it more difficult for the Japanese Prime Minister Sanae Takaichi's pro-growth government to oppose a rate hike.

Seiji Adachi stated: "Adeyemo has made it clear many times that the Bank of Japan will be the next central bank to take action. Under these circumstances, the Japanese government cannot tell the BOJ to 'hold back'." According to previous reports, sources revealed that the government led by Prime Minister Sanae Takaichi supports a near-term rate hike by the Bank of Japan, with the next move likely in September or October. Sources added that the BOJ’s concerns over a weaker yen driving up prices coincides with the government’s desire to enhance the effect of recent USD/JPY exchange rate interventions, leading both sides to agree on the necessity of a near-term rate hike.

Additionally, Seiji Adachi indicated that Japanese inflation remains strong and the Bank of Japan is likely to continue raising rates after the expected September hike. He said: "My feeling is that the BOJ will aim to take action again in January next year." "The likelihood of a prolonged rate hike cycle is increasing significantly, and rates may rise further to 1.25% or even above 1.5%—both levels once regarded as terminal rates for this cycle."

Pricing in the overnight index swaps market essentially aligns with Seiji Adachi's views, showing market expectations that the BOJ will raise rates to 1.25% in September, followed by another 25 basis point hike in January next year.

Seiji Adachi said these market expectations have reduced the BOJ's communication pressure, as the market has started to price in the upcoming policy changes in advance. He stated: "The easiest way is to allow market discussion about a rate hike to emerge early, and then, in a sense, the BOJ gradually paves the way for the move itself." "This way, the bank can avoid excessive criticism. If inflation were clearly low, they would be criticized for this, but the current situation is not like that at all."

According to data released by the Japanese government last week, Japan's core inflation rate accelerated to 1.8% in July. Core inflation rose for the second consecutive month, leading many private-sector economists to believe that Middle East conflicts have begun to push up domestic inflation in Japan. The country is highly reliant on imports for energy and food. Seiji Adachi expects that Japan’s inflation rate could accelerate to above 2.5%.

Seiji Adachi also stated that the next rate hike could also occur in December, but that may seem "a bit too fast." Assuming a BOJ rate hike in September, another hike by year-end would mean a fourth rate hike within twelve months.

Using a simple application of the Taylor rule, Seiji Adachi believes the BOJ policy rate may need to rise to around 2.75%. He noted that in this scenario, by the end of next year, the BOJ’s policy rate could reach or slightly exceed 2%, higher than economists’ 1.5% median forecast.

Seiji Adachi stated that a key concern is weak consumer spending. Data released earlier this month showed that, despite one-off boosts such as advances in air conditioner demand due to regulatory changes, Japan’s personal consumption still fell 0.1% year-on-year in the April-to-June quarter. He pointed out: "Consumer spending lacks momentum. A key issue to watch is whether the Bank of Japan can continue aggressive rate hikes if consumer spending remains weak under the shock of higher inflation and rising interest rates."