"Taking Inflation Pressures Into Account"—ECB Raises Rates Again Following June Increase
BOJ Rate Hike Also Seen as a Foregone Conclusion, Signs of Yen Carry Trade Unwind
Divergent Views on U.S. Monetary Policy: Hike or Hold?

The European Central Bank (ECB) has delivered its second policy-rate increase of the year. With international oil prices climbing and supply-chain disruptions persisting since the outbreak of the Iran war, eurozone inflation has surged, prompting the central bank to place greater emphasis on monetary tightening. The Bank of Japan (BOJ) is likewise expected to raise rates in response to yen weakness and inflationary pressures, while an upswing in the producer price index (PPI) has strengthened expectations of a September rate increase in the United States. In the U.S., however, private markets and economists remain divided, leaving considerable uncertainty over the future policy path.

ECB Delivers Rate Increase

On the 10th (all dates local), the ECB convened a monetary policy meeting in Berlin, Germany, and raised its deposit rate by 0.25 percentage points, from 2.25% to 2.50%. It also lifted the main refinancing rate and marginal lending rate by 0.25 percentage points each, to 2.65% and 2.90%, respectively. This marked the ECB’s second policy-rate increase this year. In June, the central bank raised rates for the first time since September 2023, primarily in response to a surge in international oil prices triggered by Iran’s closure of the Strait of Hormuz. In its statement following the latest decision, the ECB said, “The conflict in the Middle East continues to generate inflationary pressures, and inflation is expected to remain significantly above target for a considerable period,” adding, “Today’s decision underscores our monetary policy effort to stabilize inflation at our 2% medium-term target.”

Eurozone consumer-price inflation across the 21 countries that use the euro climbed to a three-year high of 3.3% last month, exceeding the ECB’s 2% target for a sixth consecutive month. A further acceleration in prices also cannot be ruled out. If households and businesses expect elevated inflation to persist, those expectations could become embedded in wages and the prices of goods and services, allowing inflation to spread throughout the broader economy. Analysts therefore expect the ECB to deliver one more rate increase by year-end. Francesco Pesole, an FX strategist at ING, told the Financial Times (FT), “They explicitly said inflation will remain high for a considerable period, which can be interpreted as hawkish.” He added, “At the same time, they see downside risks to economic growth, which tempers the force of the hawkish message.”

Japanese Monetary Tightening Also Seen as a Foregone Conclusion

This monetary-tightening trend extends well beyond Europe and is evident across other major economies, with Japan serving as a prime example. A Reuters poll of 68 economists conducted from the 1st through the 8th found that 66 respondents, or 97%, expected the BOJ to raise its policy rate by 0.25 percentage points, from the current 1.0% to 1.25%, on the 18th. Of those 66 respondents, 24 said the BOJ could raise the rate again to 1.50% at its October or December meeting, while 57, or 89%, expected the policy rate to reach at least 1.50% by the end of next March. Approximately 62% projected that the rate could be adjusted to at least 1.75% by the end of the second quarter next year.

The BOJ previously raised its policy rate to 1.0% at its June meeting before leaving it unchanged in July. The case for further tightening, however, had already surfaced when the hold decision was made. Policy Board member Hajime Takata was the sole dissenter at the July meeting, arguing that the rate should be increased by 0.25 percentage points to counter upside inflation risks. BOJ Deputy Governor Ryozo Himino subsequently said on the 27th of last month that “inflation exceeding the target could adversely affect the economy” and that “interest rates need to be raised in a timely manner to prevent the response to inflation from falling behind.” His recommendation was that the BOJ should pay closer attention than before to upside inflation risks as underlying inflation approaches the central bank’s 2% target. At a meeting with business leaders on the 10th, BOJ Policy Board member Kazuyuki Masu likewise stressed, “Given the currently accommodative financial conditions, it is necessary to continue raising the policy rate and adjust the degree of accommodation,” adding that “major central banks worldwide have simultaneously entered a rate-hiking cycle.”

Inflation and Currency Pressures, Compounded by U.S. Demands

The protracted weakness of the yen is widely regarded as the principal factor accelerating the BOJ’s tightening timetable. The yen has remained under sustained pressure throughout this year. Its dollar value fell to around $0.0063 in late April, the weakest level since 1990, prompting the Japanese government and the BOJ to conduct large-scale yen-buying and dollar-selling interventions from late April through early May. Immediately after the intervention, the currency rebounded to approximately $0.0066, but it soon resumed its decline and slipped back toward $0.0063. When the yen’s value sank to the low-$0.006 range in late July, the Japanese government again intervened in the foreign-exchange market, and the United States joined the effort to defend the currency on July 31. According to Japan’s Ministry of Finance, Japanese authorities deployed a total of approximately $101.3 billion in the foreign-exchange market during the roughly one-month period from July 30 through August 26. The large-scale intervention lifted the yen’s value to around $0.0064, but it failed to reach approximately $0.0066. The yen did not break above $0.0065 until recently, when its value began rising rapidly amid expectations of tighter monetary policy.

Inflationary momentum is also gathering pace. Japan’s Ministry of Internal Affairs and Communications reported last month that the nationwide consumer price index (CPI) rose 1.9% year over year in July, accelerating from 1.6% in June. Core CPI, which excludes volatile fresh-food prices, also increased from 1.6% to 1.8%, while core-core CPI, which excludes both fresh food and energy, rose from 1.7% to 1.9%, its sharpest increase in three months. U.S. pressure for higher Japanese rates has also contributed to the faster tightening timetable. U.S. Treasury Secretary Scott Bessent has recently and repeatedly argued that the BOJ needs to raise rates further. Late last month, he warned that renewed instability in the yen could exert upward pressure on U.S. interest rates; during a meeting with BOJ Governor Kazuo Ueda earlier this month, he also conveyed support for the normalization of Japan’s monetary policy.

Global Financial-Market Disruption Looms

The BOJ’s tightening campaign is highly likely to fracture the structure of the yen carry trade. Japan has maintained an ultralow interest-rate policy for an extended period, leaving a wide interest-rate differential with the United States and other major economies. Investors have therefore adopted a strategy of borrowing yen at relatively low funding costs, converting the proceeds into higher-yielding currencies such as the dollar and investing in overseas financial assets. If the BOJ raises rates, however, funding costs in Japan will increase and yields on yen-denominated assets will rise, reducing the expected return from borrowing yen to invest in higher-yielding overseas assets. Should expectations of further BOJ tightening spread, investors will inevitably have far less incentive to sell yen and hold overseas assets.

Clear signs of a yen carry trade unwind are already emerging in the foreign-exchange market. According to data released by the U.S. Commodity Futures Trading Commission (CFTC) on the 14th of last month, leveraged funds’ short positions in the yen fell 6.5% over the week from August 5 through 11, to 59,526 contracts. When the period is extended to include the aftermath of the coordinated U.S.–Japan intervention to defend the yen in late July, the relevant short positions have declined by more than half. Since the yen’s dollar value broke above $0.0065, not only leveraged funds but also real-money investors, including pension funds and asset managers, have begun reducing their short exposure to the currency. Capital repatriation is also discernible in Japanese investors’ transactions in foreign bonds. According to Reuters, Japanese investors recorded net sales of more than $19.7 billion in foreign bonds from the beginning of this year through the 22nd of last month. The growing relative appeal of Japanese government bonds has begun driving a visible shift in capital from overseas assets to domestic ones.

Table 1. Monetary-Tightening Trends Across Major Economies

The Fed’s Monetary Policy Path

As successive monetary-policy shifts across major economies roil global financial markets, the outlook for the U.S. Federal Reserve’s (Fed) decision remains divided. According to CME FedWatch, immediately after the release of the U.S. PPI on the 10th, federal-funds (FF) rate futures priced in an approximately 70% probability that the Fed would raise its benchmark rate by 0.25 percentage points at the Federal Open Market Committee (FOMC) meeting on the 16th. The implied probability, which had stood at approximately 60%–64% immediately before the release, climbed by nearly 10 percentage points within hours. Barron’s calculations showed that the probability surged from 62.1% to 74% following the PPI release, while the policy-sensitive two-year U.S. Treasury yield rose to 4.49%, its highest level since 2024. The U.S. PPI increased 0.4% month over month and 5.4% year over year in August. Core PPI, which excludes food and energy, rose 0.2% from the previous month and 4.6% from a year earlier.

Some experts, however, offered forecasts diametrically opposed to market pricing. According to a Reuters poll released on the 9th, 70% of U.S. economists expected the Fed to hold its benchmark rate steady at its September 15–16 meeting, while more than 56% said the central bank could leave rates unchanged throughout the year. Eli Nir, a U.S. economist at TD Securities, said, “If everything evolves as expected, the Fed will remain on hold next week,” while adding, “If the inflation data produce an unexpected upside surprise, however, there is a strong possibility that a rate-hiking cycle could begin.” The “inflation data” Nir cited are understood to refer to the August CPI, due to be released by the U.S. Department of Labor on the 11th. The August CPI is the final major inflation indicator available to the Fed before its rate decision on the 16th.