BOJ rate hike likely, yen rally at risk

As the Japanese yen has been active this week, attention is on the Bank of Japan ahead of its upcoming policy meeting next week.

Ahead of the central bank's meeting scheduled for 17-18 September, the likelihood of a rate increase has climbed, with the market pricing in roughly a 79% chance of a 25 basis point hike. That figure is not drastically different from late last week, when the probability stood at around 75%.

Nevertheless, the yen has rallied sharply this week, breaking through important support levels in the USD/JPY pair as it declined. The key issue is whether the currency can maintain those advances through and beyond the BOJ's decision.

BOJ policymakers set the tone

The BOJ governor has already signaled the possibility of a September move, stating that officials will evaluate if inflation and economic trends are developing as projected. Meanwhile, board member Hajime Takata has been even more direct, advocating for faster rate increases here.

As noted last week, it is striking how the central bank's rhetoric has evolved over the last month, especially following the coordinated intervention by the US and Japan to support the yen.

"Before all this, it was still the usual careful and more curated approach in trying to leave all options on the table. It was a case of always saying that "we cannot confirm nor deny" whether we will raise interest rates. Now after the joint intervention it's no longer about if we are going to raise interest rates. But suddenly, it's about needing to do more perhaps and not just stick to their previous convention."

How much further can the yen rally from here?

This situation becomes more nuanced.

A rate hike in September is quickly turning into the consensus view rather than a possible shock. Since expectations are already priced into the bond market and the yen, a straightforward rate increase could trigger a typical 'buy the rumor, sell the fact' reaction.

Here, I would contend that Ueda's remarks on the next hike will be more important.

If Ueda repeats his earlier statement that future steps will be gradual and reliant on data, it will not inspire much belief that the pace of tightening will accelerate next year.

Currently, traders anticipate a further 25 basis point increase in January of next year, with about a 61% chance of it occurring as early as December. By mid-2025, the market is pricing in around 81 basis points of total rate increases, counting next week's expected move.

Thus, rather than a single hike every half year, traders expect the BOJ to act at least three times between now and June next year.

Although a September increase would bolster the BOJ's narrative of policy normalization, the decision alone might not be sufficient to drive the yen higher again. For USD/JPY, the more significant catalyst is whether the BOJ can persuade markets that raising rates to 1.25% next week represents another step in an ongoing tightening cycle, rather than just another cautious pause.

The technical perspective

USD/JPY has fallen notably since last week, declining from 160.00 to around 153.00 currently. After breaking through crucial support levels, attention now turns to the January and February lows near 152.00-152.25. That zone is the critical threshold to monitor for any further decline toward the 150.00 level.

For those looking to buy on dips, a move back above 155.00 is necessary to reclaim some technical control before aiming for further upside.