BOJ Rate Hike to 1.25% Fails to Lift Yen as Fed Tightening Derails Japan

U.S.-Japan Rate Gap Seen Staying Wide

Yen Drops 4 Per Dollar in 10 Days

The yen has weakened instead of strengthening even as the Bank of Japan is all but certain to raise its benchmark interest rate to 1.25% on Sept. 18, the highest level in 31 years. The reversal comes after the Federal Reserve raised interest rates for the first time in three years and two months and signaled it could tighten further, fueling expectations that the U.S.-Japan rate gap will not narrow as quickly as previously expected.

In New York trading on Sept. 17, the yen at one point fell into the low 156s against the dollar. Earlier this month, the currency had strengthened into the 152s on expectations of a BOJ rate increase, only to shed about 4 yen in just 10 days.

The BOJ is poised to raise its policy rate from 1.0% to 1.25% at its monetary policy meeting on Sept. 18. In Tokyo financial markets, talk has also emerged of a possible additional increase in December.

A BOJ rate increase would normally support the yen by narrowing the interest-rate gap with the U.S. This time, however, the Fed's return to tightening has offset that effect. Even if the BOJ raises rates by 25 basis points at a time, the gap will not shrink if the U.S. moves at a similar or faster pace.

Expectations for yen strength are also fading quickly. The Nihon Keizai Shimbun reported that eight of 10 foreign-exchange specialists in Japan expect the yen to weaken again by year-end. They cited the still-wide U.S.-Japan rate gap even if the BOJ delivers another increase, as well as other factors behind yen weakness such as rising global oil prices and a worsening trade balance. Higher oil prices raise Japan's import bill because the country relies heavily on crude imports, increasing pressure to sell the yen. That in turn lifts import prices and could push the BOJ toward additional rate increases, creating a vicious cycle.

The won also fell sharply against the dollar. As of 3:30 p.m., the won-dollar exchange rate stood at 1,382.2 won, up 13.6 won from the previous session. It has climbed nearly 40 won over the past three trading days.

Choi Man-su, Tokyo correspondent / Shim Sung-mi, reporter bebop@hankyung.com