With the Japanese yen on the move this week, attention is firmly on the Bank of Japan ahead of its next monetary policy decision next week.

Expectations for another rate hike are rising sharply ahead of the meeting on 17-18 September, with markets now assigning a roughly 79% probability to a 25 bps rate hike. That is not much changed from the end of last week, when the odds stood at around 75%.

Even so, the yen has produced a strong rally this week, breaking key defensive lines in USD/JPY on the way down. The question now is whether the currency can hold its gains through the central bank decision and beyond.

The backdrop matters here. The BOJ ended eight years of negative interest rates in March 2024 and has been raising rates only gradually since, moving in small steps as it cautiously normalises policy after decades of ultra-loose monetary settings. A hike to 1.25% next week would continue that incremental path, which is why the market's focus is less on the decision itself and more on the guidance around it.

BOJ policymakers set the tone

The governor of the Japanese central bank has already opened the door to a move in September, saying that policymakers will assess whether inflation and economic developments are evolving in line with their forecasts. Meanwhile, board member Hajime Takata has been even more explicit, arguing for more timely rate hikes.

As noted last week, the conversation within the central bank has shifted noticeably over the past month or so, particularly after the joint intervention by the US and Japan to defend 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 is where things become more complicated.

A September rate hike is rapidly becoming the consensus rather than a potential surprise. With expectations already heavily reflected in the rates market and in the yen itself, a simple rate hike decision may produce the classic buy-the-rumour, sell-the-fact response.

In this instance, what matters more will be what Ueda says about the next rate hike. If he sticks to his previous message that future moves will remain slow and data-dependent, that will not inspire much confidence that the BOJ will step up the pace going into next year.

As things stand, traders are pricing in another 25 bps rate hike for January next year, with roughly 61% odds of that coming as early as December this year. By June next year, traders are pricing in about 81 bps of rate hikes, including the one next week.

So rather than one rate hike every six months, traders are anticipating the BOJ to move at least three times between now and the middle of next year.

While a September hike would reinforce the BOJ's policy normalisation story, the decision itself may not be enough to sustain another leg higher in the yen. For USD/JPY, the bigger and more crucial trigger would be whether the BOJ convinces markets that moving to 1.25% next week is another step in a continuing hiking cycle, or simply the next cautious pause point.

For readers watching the broader picture, this meeting also feeds into the global rate cycle narrative: with other major central banks weighing cuts, a BOJ tightening path would keep the yen's interest rate differential with the dollar and euro narrowing, a key driver of carry-trade flows that have weighed on the currency in recent years. What to watch beyond the statement is Ueda's press conference and the board's vote split, which have historically offered the strongest signals about the pace of subsequent moves.

The technical perspective

USD/JPY has already fallen significantly since last week, dropping from 160.00 to near 153.00. Having taken out key technical support levels, all eyes are on the January and February lows closer to 152.00-25 next. That will be the key line in the sand for anyone chasing a further downside move towards the 150.00 mark.

For dip buyers, a push back above 155.00 will be needed to regain any semblance of technical control before looking to revisit upside potential.

Source: ForexLive