Japan’s central bank is in focus this week as its next interest-rate meeting comes amid new 40-year lows for the yen against the US dollar.

Key points:

• The Japanese yen is approaching new 40-year lows against the US dollar, nearly matching its latest record from last week.
• The Bank of Japan will decide on interest-rate changes on July 31, with rates already at 1%, their highest since September 1995.
• Analysts have warned that the yen carry trade could unwind again, repeating a major crypto headwind from 2024.

Dollar-yen edges back toward 40-year record

Data from TradingView showed USD/JPY approaching 164 on Tuesday, just a fraction below the new 40-year highs set last week.

USD/JPY 12-month chart. Source: Cointelegraph/TradingView

The yen’s role as a funding currency gives Bank of Japan monetary policy an outsized influence on global markets. Japan’s currency market is marked by minimal capital controls and liquidity that is unmatched among non-dollar currencies.

Japan’s persistent current account and trade surpluses in earlier decades, together with structurally low interest rates, made the yen one of the world’s most important funding currencies. Since Japanese inflation began picking up in 2022, however, the risk has grown of carry trade unwinds that could be accompanied by a liquidity crunch.

On Thursday and Friday, the Bank of Japan (BoJ) will decide whether to adjust its benchmark rate, which at 1.0% is currently at its highest level since 1995.

Markets broadly expect rates to remain unchanged. Market-implied odds of a rate hold stand at 98%, following the central bank’s latest increase in June. Prediction service Polymarket puts the odds of no change at 99% as of Tuesday.

At the time of the June meeting, the BoJ indicated that additional hikes could come later. In a summary from that meeting, it pointed to inflation trends reflected in the Consumer Price Index (CPI), as well as the historically low rates maintained over the past three decades, as reasons for the move.

“As for the future conduct of monetary policy, given that underlying CPI inflation has been approaching 2% and financial conditions have been accommodative, it is appropriate for the Bank to continue to raise the policy interest rate and adjust the degree of monetary accommodation, in response to developments in economic activity and prices as well as financial conditions,” the BoJ said.

Since then, another headwind has gathered pace: a weakening yen that has remained above the key 160 level against the dollar, despite easing after the June rate hike. That keeps the currency near levels that matter not only for Japan’s inflation outlook, but also for global positioning in markets that have come to rely on low-cost yen borrowing.

The BoJ has previously said a weaker yen could weigh on CPI growth and constrain consumer spending power.

“Attention should also be paid to the point that, with firms’ behavior shifting more toward raising wages and prices recently, exchange rate developments are, compared to the past, more likely to affect prices, and that such moves could affect underlying CPI inflation through changes in inflation expectations,” the central bank said in its Outlook for Economic and Prices document released after its April meeting.

Yen carry trade unwind risk spreads to global markets

For crypto traders, developments in the yen are especially important. The yen carry trade can serve as a source of liquidity for crypto markets, and it is heavily affected by BoJ actions aimed at stabilizing the yen’s exchange rate against the dollar. As Cointelegraph reported, interventions in August 2024 triggered a rapid unwinding of the carry trade, with an immediate negative impact on Bitcoin and altcoins.

Related: Rate path still divides investors: Five things to know in Bitcoin this week

Now, with USD/JPY pushing back toward new 40-year highs, concern is rising that a similar move could happen again.

“That trade only works if two conditions remain intact. Japanese interest rates remain exceptionally low. The yen remains broadly stable or continues depreciating,” analyst Ricky Ho wrote in his latest X commentary on Monday.

Ho said carry-trade unwinds are “rarely gradual” because of the high leverage used by participants.

He warned that any shift in BoJ policy could have broader consequences for a global economy that has long adjusted to Japan’s monetary environment.

“Ultimately, we think investors remain too focused on whether the BOJ hikes in September, October or December. The more important issue is that the direction of policy has fundamentally changed,” Ho said.