The Bank of Japan raised interest rates for the first time in 17 years

Tuesday morning brings weakening of the Japanese yen which is the result of the Bank of Japan's decision. The institution raised interest rates this morning for the first time since 2007. At the same time, the institution abandoned yield curve control. USD/JPY currency pair rose above the level of 150,00 and thus the strengthening of JPY from the beginning of March was fully eliminated. However, the market still does not know what the shape of monetary policy will look like in the coming months.

There will be no cycle of increases

Bank of Japan actually raised the cost of money this morning for the first time since 2007. The short-term interest rate is now set between 0 and 0,1 percent. At the same time, the target for long-term government bonds was abandoned, although the BoJ still intends to buy a similar number of them as before, just without a clear target. On the other hand, the institution stops buying ETFs and REITs, a purchases of commercial paper and corporate bonds will be gradually limited and stopped completely within the next 12 months. Despite these rather extensive actions, the yen reacted negatively to this decision. It remains unclear what will happen next. There is no indication that the BOJ is planning a real cycle of interest rate increases.

The yen could only benefit if the central bank suggests a real cycle of monetary tightening and not just the adjustment of monetary conditions that we witnessed this morning. The increase itself, which has just materialized, was fully priced in by the market, hence the reaction of the FX market.

Today, the BoJ took the first step towards abandoning ultra-expansionary monetary policy, but it was not a clear "hawkish" turn, but rather a "dovish" rate increase. Now inflation is likely to be the key. If there are further signs that it remains persistently at 2%, there may be further steps towards normalizing monetary policy.

A balanced set of interest rate risks

The Reserve Bank of Australia also decided on rates today. While it was unlikely that the RBA would raise interest rates again, the decision to keep them at 4,35% has put some pressure on the AUD. It seems that some market participants expected a more hawkish statement. However, given recent progress on disinflation, I believe it was fair to talk about a more balanced set of risks to the interest rate. In practice, the next move in interest rates will probably be a cut. RBA though will maintain a cautious approach in the coming months and the reduction in interest rates will probably take place in the second half of the year. The AUD/USD pair fell to 0,6510, the lowest level since March 6.

Source: Łukasz Zembik, OANDA TMS Brokers