Bank of Japan Raises Interest Rates to 0.75% as Yen Falls to Historic Lows

TLDR

• Japan’s central bank increased its key interest rate to 0.75%, the highest since 1995, but the yen dropped to record lows instead of gaining strength.
• The dollar climbed to 157.67 yen while the euro and Swiss franc hit all-time highs against the Japanese currency on Monday.
• Japan’s real interest rate remains negative at -2.15% while the US sits at +1.44%, driving investors to borrow yen and invest in dollar assets.
• Japanese authorities warned they will take action if excessive currency moves continue, with intervention likely if the dollar reaches 160 yen.
• Bitcoin gained 1% after the yen’s decline but analysts expect the rally could reverse if Japan intervenes to support its currency.

The Bank of Japan raised its benchmark interest rate to 0.75% on December 19, reaching levels not seen since 1995. The increase was meant to strengthen the yen. The result was the exact opposite.

The Japanese currency fell to record lows against major currencies on Monday. The dollar reached 157.67 yen. The euro climbed to 184.90 yen and the Swiss franc touched 198.08 yen, both historic highs against the yen.

Atsushi Mimura, Japan’s vice finance minister for international affairs, said recent currency movements were “one-sided and sharp.” He warned that officials stand ready to take “appropriate action” against excessive exchange rate moves. Finance Minister Satsuki Katayama echoed these warnings last week.

Market participants believe intervention becomes likely if the dollar approaches 160 yen. The BOJ previously sold around $100 billion last summer at similar levels to prop up the currency.

Why the Rate Increase Failed to Help the Yen

Several factors explain why the yen weakened after the rate hike. The move was fully expected by markets before it happened. The overnight index swap market showed nearly 100% odds of the increase before the BOJ meeting.

This created a “buy the rumor, sell the news” pattern. Investors who purchased yen ahead of the decision sold afterward to capture profits. The selling pressure pushed the currency down immediately after the announcement.

Japan’s real interest rate stays deeply negative despite the increase. With inflation at 2.9% and the nominal rate at 0.75%, the real rate is approximately -2.15%. The US real rate stands at about +1.44%.

This gap of over 3.5 percentage points has revived the yen carry trade. Investors borrow yen at low rates and invest in higher-yielding US assets. They profit from the difference while the weak yen persists.

BOJ Governor Kazuo Ueda disappointed markets during his press conference after the decision. He gave no clear guidance on when future rate hikes might occur. Ueda stressed there was “no predetermined path for further rate hikes” and called estimates of the neutral rate “highly uncertain.”

He minimized the importance of reaching 30-year highs, saying it “has no special meaning.” Markets interpreted this as the BOJ showing no urgency to tighten policy further.

Structural Problems Limit Japan’s Options

Robin Brooks from the Brookings Institution highlighted deeper issues. He said Japan’s long-term interest rates are too low given the country’s debt burden. Government debt sits at 240% of GDP.

The BOJ has suppressed yields by buying massive amounts of government bonds. Brooks explained that without these purchases, yields would spike and potentially cause a debt crisis. He described the situation as a choice “between a debt crisis and currency debasement.”

Prime Minister Sanae Takaichi has pushed major fiscal stimulus since October. This marks Japan’s largest spending package since the pandemic. Markets worry this fiscal expansion undermines efforts to stabilize the currency.

Bitcoin rose 1.04% to $88,949 following the yen’s weakness. Crypto experts see this gain as potentially short-lived. If Japan intervenes to support the yen, it could hurt Bitcoin by unwinding carry trades and reducing market liquidity.

Bitcoin has dropped 20-31% after each of the last three BOJ rate hikes. In August 2024, an unexpected rate increase sent the Nikkei down 12% in one day with Bitcoin falling alongside it.

Markets forecast the dollar-yen rate will finish the year near 155 yen. A break above 158 yen could push toward this year’s high of 158.88 yen or last year’s peak of 161.96 yen. Intervention risk rises sharply as the rate nears 160 yen.