With the yen breaking through 156, has the Bank of Japan reached the tipping point where it will be forced to tighten monetary policy earlier than expected?

The US dollar fell below the 156 level against the Japanese yen, further increasing pressure on the Bank of Japan to raise interest rates. Following the Federal Reserve's 25 basis point rate hike and hawkish signals, expectations of a widening US-Japan interest rate differential have resurfaced, with the yen falling as much as 1% to 156.42.

Meanwhile, with the Bank of Japan's policy meeting on September 17-18 approaching, market expectations for an interest rate hike are almost certain. Overnight index swap market data shows a 98.2% probability that the Bank of Japan will raise its benchmark interest rate by 25 basis points from 1%.

With the market having almost fully priced in a 25-basis-point rate hike, investors' focus has shifted to what policy signals Kazuo Ueda will release. The market will be closely watching whether the Bank of Japan hints at further rate hikes, or even the possibility of a one-off 50-basis-point increase.

The renewed weakening of the yen has also increased policy pressure on the Bank of Japan. A depreciating currency will push up import costs, further impacting domestic prices; and if the Bank of Japan raises interest rates less than expected, the yen may continue to come under pressure.

The pressure of the US-Japan interest rate differential is intensifying again, and a rate hike by the Bank of Japan is almost a certainty.

According to Bloomberg, the Federal Reserve announced a 25-basis-point interest rate hike after concluding a two-day Federal Open Market Committee meeting. Fed Chairman Kevin Warsh stated that inflation remains too high and has persisted for too long, suggesting the possibility of further rate hikes in the future.

The Federal Reserve's renewed tightening of monetary policy has reinforced expectations of a widening interest rate differential between the US and Japan. Glen Yin, head of research at ACCM, stated that Japan faces significant pressure to mitigate the impact of yen depreciation through interest rate hikes and hawkish signals; if the Bank of Japan's policy力度 (intensity/strength) falls short of market expectations, the risk of the yen moving towards the 160 level in the short term will increase.

Currently, the probability of the Bank of Japan raising interest rates by 25 basis points has reached 98.2%. Therefore, the core variable of this meeting is not whether or not interest rates will be raised, but rather Ueda's post-meeting statement and guidance on the subsequent pace of interest rate hikes. If the Bank of Japan signals consecutive interest rate hikes, market pricing for the yen and Japanese government bonds may adjust accordingly.

The Bank of Japan previously used negative interest rates, yield curve control, and large-scale bond purchases to lower domestic financing costs during the Federal Reserve's rate hike cycle, partially buffering the impact of US interest rate changes. With these unconventional policies exiting in 2024, changes in US interest rates can now be transmitted more directly to the Japanese exchange rate and bond market.

Against this backdrop, the yen's fall below 156 is not only a change in exchange rate, but also further highlights the pressure the Bank of Japan faces in accelerating the normalization of monetary policy.

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