The Bank of Japan raised its key interest rate Friday as expected, lifting its benchmark from 1% to 1.25%, its highest level since 1995.
And the yen responded by... falling. Hard. The currency suffered its worst daily drop in nine months. The dollar jumped 1.2% against it to a two-week high of 157.84 yen. That's the largest daily gain since December and the biggest weekly rally since September 2024.
So the central bank hikes, and the currency tanks. Welcome to foreign exchange, where the headline is rarely the story.
The Message Did The Damage
The decision was split 7-2, with board members Toichiro Asada and Ayano Sato dissenting. Both are seen as reflationists and were appointed by Prime Minister Sanae Takaichi earlier this year.
Governor Kazuo Ueda reaffirmed the central bank's commitment to further rate hikes as economic conditions evolve. But traders seized on his dovish caveat that monetary policy will remain accommodative enough to support growth.
The hike itself was fully priced into currency and bond markets beforehand. So the only new information was the messaging, and the market read it as dovish.
"They've just clearly underwhelmed versus expectations here," said Ray Attrill, head of FX strategy at National Australia Bank.
Inflation data that morning pointed the same way. Core inflation, which strips out fresh food prices, eased to 1.7% in August from 1.8% in July, the first slowdown in four months.
Kelvin Lam, senior economist at Pantheon Macroeconomics, expects the BoJ to finish 2026 at 1.25%, with a move to 1.50% in the first quarter of 2027 and a terminal rate around 1.75%.
U.S. Central Bank Moves in Similar Direction
The Federal Open Market Committee raised its benchmark rate by 25 basis points to a target range of 3.75%-4%, its first increase since 2023, in a unanimous 12-0 vote.
The updated dot plot showed 16 of 18 participants expecting another increase this year.
That leaves roughly 2.5 percentage points between what a dollar deposit earns and what a yen deposit earns.
The carry trade runs on exactly that spread: borrow cheaply in yen, convert to dollars, collect the higher yield.
A quarter-point hike in Tokyo does not close a gap that wide, and a Fed still tightening reopens it.
Finance Minister Satsuki Katayama said Tokyo won't hesitate to conduct further coordinated action, following a joint U.S.-Japan intervention to support the yen in late July.
The currency had rallied to a seven-month high in early September on bets the BoJ would deliver a run of hikes. Those bets are now being unwound.
The Invesco CurrencyShares Japanese Yen Trust (NYSE: FXY) was 1.1% lower in premarket trading on Friday.
