Citi Forecasts BOJ Rate Hike to 1.25%, Flags Political and Fed Risks for Yen

The Bank of Japan is expected to raise its key policy interest rate to 1.25% at its upcoming meeting, according to a research note from Citi Research. However, analysts caution that the yen's near-term direction will be heavily influenced by political dynamics within the BOJ's Policy Board and the U.S. Federal Reserve's next move.

BOJ's Internal Vote Scrutinized

While a rate hike this month is largely priced in by markets, investors will be closely watching the votes of two board members, Toichiro Asada and Ayano Sato, who are seen as aligned with Prime Minister Sanae Takaichi’s reflationary economic agenda. Citi highlights two potential outcomes:

• Dissenting Votes: If both members vote against a rate increase, it would signal continued political pressure on the BOJ to maintain low borrowing costs. Citi suggests this could weaken the yen, potentially pushing the U.S. dollar back toward the 155 yen mark.
• Unanimous Decision: A unanimous vote to hike rates could be interpreted as the Takaichi administration yielding to calls for monetary policy normalization, including from U.S. Treasury Secretary Scott Bessent.

Investors will also analyze the BOJ’s Summary of Opinions, due October 1, for signs of ongoing government resistance to monetary tightening. At the June meeting, a Cabinet Office representative voiced opposition to raising rates to 1%.

Federal Reserve Decision Holds Key

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The yen's path also remains highly dependent on the U.S. Federal Reserve’s interest rate decision next week, Citi's note stated. A surprise rate hike by the Fed would make it difficult for the dollar to sustain a level below 155 yen, especially if U.S. equity markets remain resilient.

Even if the Fed holds rates steady, a positive reaction in stock markets could limit the yen's appreciation, keeping the dollar-yen pair supported above the 150 level. Downward momentum could, however, temporarily push the dollar toward 152 yen.

Longer-Term Outlook

Looking further ahead, Citi projects that the gradual narrowing of the interest rate differential between the U.S. and Japan will fuel a broader unwinding of yen carry trades. This dynamic is expected to establish a more definitive downward trend for the dollar against the Japanese currency.