A Bank of Japan interest rate hike is practically a certainty; the key question is how to deal with the pressure from the Takashi City government and Bessant.

The Bank of Japan is expected to raise its policy rate by 25 basis points to 1.25% this week, the highest level in 31 years, an outcome already fully priced into by the market. The real suspense has shifted from whether or not to raise rates to how Governor Kazuo Ueda will maintain the Bank of Japan's independence amidst dual political pressures from Washington and Tokyo.

The latest and most significant variable comes from the United States: Treasury Secretary Bessant has repeatedly claimed that the Bank of Japan has "asymmetric information" regarding its "next move," putting unprecedented pressure on Kazuo Ueda's independence. Meanwhile, Prime Minister Sanae Takaichi favors reflation and low interest rates, and her camp may exert pressure on the central bank through Minister of Economic and Fiscal Policy Takahide Kiuchi.

The direct market impact is already evident: the yen has rapidly risen above 153 in the past week, returning to its highest level since February, and the yield on 10-year Japanese government bonds has risen to its highest level in 30 years. However, analysts point out that the rapid appreciation of the yen has actually provided political cover for Kazuo Ueda, the "Young Hawk"—the exchange rate has already done part of his job.

More subtly, Japanese authorities had just intervened in the foreign exchange market in July and August in cooperation with the United States, totaling $96 billion. The market will scrutinize the wording of this statement and the press conference word for word, as any misstep could reignite a rapid unwinding of carry trades.

Bessant's "Asymmetric Information" and Washington's Intervention

Bessant's pressure on the Bank of Japan has moved from behind the scenes to the public eye. His repeated claims of "asymmetric information" regarding the BOJ's "next move" have placed unprecedented pressure on Kazuo Ueda's independence. The FT report points out that Washington is willing to see higher Japanese interest rates and seems increasingly comfortable intervening in Tokyo's monetary policy affairs.

Richard Katz, an economist who has long focused on Japan, said: “Ueda is under a lot of pressure because this is the kind of time when large market swings are more about market sentiment’s interpretation of fundamentals than changes in fundamentals or policies themselves.” He added that Ueda, who was an academic before becoming governor in 2023, is not known for his communication skills.

The market will scrutinize the Bank of Japan's statement and Ueda's remarks to determine the extent to which this decision is based on the need to stabilize inflation and the extent to which it is based on the responsibility to maintain the yen's upward momentum.

Internal divisions between the Kaohsiung City camp and the policy committee

Domestic political pressure in Japan is also significant. Sanae Takaichi favors reflation and low interest rates, directly contradicting Washington's policy stance. A key figure is Economic and Fiscal Policy Minister Takahide Kiuchi—he will attend this central bank policy meeting, and his remarks, which will appear in the subsequently released minutes, may reveal the Takaichi camp's views on monetary policy or pressure to slow the pace of future interest rate hikes.

Kazuo Ueda also faces turmoil within the policy committee. At the July meeting, the central bank chose to hold rates steady, while committee member Hajime Takada voted in favor of a rate hike. This month, Takada publicly hinted that the central bank should consider more aggressive measures to maintain its lead, such as faster or larger rate hikes. The Bank of Japan last raised rates to 1% in June; if the rate hike occurs as expected on Friday, it will be significantly faster than the previous normalization pace of "once every six months."

The sharp rise of the yen and the yield of Japanese government bonds: a double-edged sword

The yen has fluctuated wildly over the past six weeks, with the yield on 10-year Japanese government bonds rising to a 30-year high. Currency analysts warn that a misstep by the Bank of Japan or a failed message from the governor could reignite a rapid unwinding of carry trades.

On the other hand, the yen broke through 153 in the past week, returning to its highest level since February and exceeding the level achieved by previous interventions. Analysts say this has actually given Ueda and Kazuo Ueda political cover. The biggest fear for the Bank of Japan and Ueda is that acting too aggressively will push the Japanese economy back into deflation—a predicament that Japan took decades to escape.

Katz pointed out that although the overall inflation rate of 2.3% is higher than the central bank's 2% target, demand-driven inflation remains weak and real wage growth is sluggish. "Japan faces stagflation," he said.

“This is a tricky situation for any central bank, and I doubt the market would be happy to hear Ueda emphasize these dilemmas.”

After intervention in the foreign exchange market, the scope for coordination narrowed.

In July and August, Japanese authorities, in cooperation with the United States, intervened in the foreign exchange market for $96 billion to support the yen, which was then near a 40-year low, hovering around 164 yen to the dollar. The joint intervention eased depreciation pressures but also introduced new constraints: the market would judge whether the interest rate hike was aimed at stabilizing inflation or maintaining the yen's momentum.

"Ueda will try not to surprise the market...the market is becoming fragile," said Osamu Takashima, chief foreign exchange strategist at Citigroup in Tokyo. Tomohiro Ota, senior economist at Goldman Sachs, believes that while the market is beginning to price in an accelerated path of consecutive rate hikes in September and October, this outcome is unlikely unless inflation significantly exceeds expectations. Analysts are also watching whether the phrase "financial conditions remain accommodative" will be retained after the rate hikes.

Market focus will be on the wording of the statement from the September 17-18 meeting and Kazuo Ueda's press conference; the Japanese national CPI for August (expected to be 2% year-on-year), released on the same day, will provide new clues about inflation.

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