'A missed opportunity': US and Japan at odds over rate hikes to stem yen weakness

The United States and Japan, which made an unusual joint intervention in currency markets to halt the yen's slide, are now showing a clear divergence over the pace of interest rate hikes. US Treasury Secretary Scott Bessent believes monetary tightening by the Bank of Japan (BOJ) is key to resolving the yen's weakness over the past year, while Japanese Prime Minister Sanae Takaichi has taken the position that raising rates too quickly could dampen the country's economic recovery.

The BOJ has raised interest rates twice since Takaichi took office last October. Japan's benchmark interest rate currently stands at 1 percent.

According to Bloomberg on Friday, market participants have raised concerns that the BOJ missed a chance to maximize the policy impact after it held rates steady following the US intervention to buy yen last month — the first such move since 1998.

"Japan missed a 'golden opportunity' at the time," said Peter Vassallo, a portfolio manager at BNP Paribas Asset Management's US unit. "Japan stepped in to buy yen but sent a mixed signal by keeping rates on hold."

Markets expect the BOJ to raise rates again around September or October, pointing to the yen's recent approach toward the 160-per-dollar level despite last month's joint US-Japan currency intervention.

However, Takaichi, who has pursued expansionary fiscal policy to stimulate growth, has been visibly wary of moving too quickly on interest rates.

The summary of the BOJ's July monetary policy meeting showed board members flagging the risk that inflation could prove stronger than expected. Japan's consumer price inflation has eased somewhat in recent months but has exceeded the BOJ's 2 percent target for most of the past four years.

Bessent, by contrast, believes the BOJ has already fallen behind. He said last August that the central bank was "falling behind" in its monetary policy response, and in October of that year urged the Takaichi government to give the BOJ room to maneuver in addressing inflation.

On the day of the joint yen-buying intervention, Bessent said on X, formerly Twitter, that he looked forward to meeting BOJ Governor Kazuo Ueda later this month. He subsequently acknowledged the US role in the intervention while doubling down on his support for Japan's "resolute market and monetary policy measures" to correct the yen's weakness.

Mark Dowding, chief investment officer for fixed income at RBC Global Asset Management, said "Takaichi wants to maintain accommodative policy to maximize growth, but a weaker yen could stoke inflation and hurt her approval rating. If the yen weakens further without the BOJ raising rates, the currency market intervention will be judged a failure."

Observers say that even Takaichi may now have little choice but to accept further rate hikes. Bloomberg noted that "Takaichi's approval rating has slipped in recent weeks as public concern over the cost of living has grown, while within the BOJ, wariness about the risk of rising prices has also increased."

Bloomberg reported Thursday, citing sources, that the Japanese government has shifted toward a more favorable stance on an early BOJ rate hike. One source said the government had signaled to BOJ Governor Ueda ahead of the central bank's July 31 monetary policy meeting that he was welcome to make hawkish remarks at his press conference.

Bloomberg said the Takaichi government has begun to recognize that blocking further BOJ rate hikes could actually amplify market concerns about Japan's fiscal health. Heightened fiscal instability could also weigh on the 14-year investment plan at the core of Takaichi's growth strategy.

Kobayashi Shinichiro, a senior economist at Mitsubishi UFJ Research and Consulting, said "Under normal circumstances, Takaichi might not prefer rate hikes, but given the current situation, she is increasingly inclined to accept them."