The door for the Bank of Japan to raise interest rates has been opened! Will an artificial financial storm descend? The yen may still struggle to stage a "major counteroffensive"...

Beijing time Tuesday, the Bank of Japan will conclude its two-day policy meeting. Regarding this interest rate decision, the market's focus is undoubtedly whether the Bank of Japan will carry out its first interest rate hike in 17 years?

Since taking over from former Bank of Japan Governor Haruhiko Kuroda, market speculation about the Bank of Japan under the leadership of academic出身的植田和男 exiting negative interest rates has been rampant.

Now, the window for the Bank of Japan to exit its negative interest rate policy is slowly opening. The latest data shows that Japan's wage increases, persistent inflation, and a certain resilience in the economy have led the market to expect that the Bank of Japan may end its ultra-dovish negative interest rate and Yield Curve Control (YCC) policy as early as tomorrow.

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Some Japanese media have also hinted that Bank of Japan members are in deep negotiations about raising interest rates.

This speculation has led to a decline in the Japanese stock market, particularly the Nikkei 225 index, from historical highs and has caused the US dollar to yen to fall to 146 against the yen in the past week. However, after a weekend, the Nikkei index rebounded significantly on Monday, and the US dollar to yen returned to around 149.

Is the probability of a rate hike in March still a toss-up?

The Bank of Japan has outlined the so-called "virtuous cycle of inflation," which includes signs of wage increases and sticky inflation. These are two main considerations the central bank hinted at when it began to end YCC and negative interest rate policies.

With Japan's largest union Rengo announcing a 5.28% total wage increase, the largest in 30 years, Japan's revision of last year's fourth-quarter GDP data to escape "technical recession," and inflation consistently above the central bank's 2% target, the door for the Bank of Japan to end its ultra-loose policy may be opening.

As a result, the market has begun to digest the possibility of the Bank of Japan raising interest rates by 20 basis points, raising short-term interest rates from -0.1% to 0.1%. This would be the Bank of Japan's first interest rate hike since 2007. However, analysts still disagree on whether this move will be implemented in March or April.Bank of America stated in its latest report that there are three key reasons that will push the central bank to raise interest rates in March. The first is the recent improvement in capital expenditure data, which paints a better picture of domestic demand and strengthens the case for a rate hike in March; the second is the aggressive wage demands from labor unions, which increases the likelihood of a significant wage increase in Tokyo for the fiscal year 2024 compared to the previous year; and finally, there are numerous Japanese media "trial balloons" suggesting that "discussions on the post-YCC framework have reached a very advanced stage."

However, they also pointed out that since the Bank of Japan will have more data available by April, a March rate hike is not a "done deal."

Citi analysts lean towards the view shared by many market observers that the Bank of Japan will only raise interest rates in April, but the central bank may send a signal on Tuesday to end its ultra-dovish policy. Citi analysts said in a report:

"We believe that the likelihood of a rate hike in April is greater than in March... Bank of Japan officials have indicated a gradual approach. Moreover, the advantage of a rate hike in April is the availability of more data for decision-making."

Citi expects that by January 2025, Japanese interest rates will reach 0.25%.

W. Brad Bechtel, Global Head of Foreign Exchange at Jefferies in New York, stated that if the Bank of Japan decides on Tuesday to raise interest rates by 10 basis points to 0%, this should trigger a moderate market reaction. However, if the central bank further raises rates by 20 basis points to 0.1%, it could provoke a more severe market reaction, leading to a sell-off in risk assets and a stronger yen, with a longer duration.

He said that ultimately, the Bank of Japan "will not raise rates more than three times in any case, possibly raising rates by 30-50 basis points before the end of the year."

Bechtel added that if Japanese policymakers are forced to raise rates more quickly due to actual conditions, the market will begin to destabilize, "but I think we must first observe the data to see if this situation begins to become a reality, and this risk will not emerge for at least four to five months."

Will a rate hike also fail to boost the yen?

The market generally expects that if the Bank of Japan raises interest rates, the US dollar against the yen will fall sharply, as the widening interest rate gap between the US and Japan over the past two years has been a key factor affecting the yen's trajectory. Any signal of the end of the Bank of Japan's ultra-dovish policy is also expected to support the yen and lower the US dollar against the yen.Speculations about a shift in the Bank of Japan's policy have caused significant fluctuations in the US dollar against the Japanese yen over the past week. The currency pair once fell to 146 and rebounded to around 149 on Monday, with some strategists also significantly lowering their expectations for a "great counterattack" of the yen earlier.

Nomura Securities, Mizuho Bank, and Citigroup Global Markets Japan have all substantially lowered their expectations for the yen in recent weeks. The median forecast from foreign media surveys is that by the end of 2024, the yen will be at 140 against the US dollar, only 5% higher than the current level, while the median forecast for the end of 2023 is 135.

The latest expectations from the aforementioned investment banks imply that once Haruhiko Kuroda announces an exit from the zero interest rate policy, the prospects for the yen's appreciation are bleaker than imagined. This could put traders and investors hoping for a yen recovery in a difficult position, who have already suffered losses for three years.

Analysts at Mitsubishi UFJ have stated that even if the Bank of Japan ends its negative interest rate policy and Yield Curve Control (YCC), the Bank of Japan's meeting tomorrow may not be a decisive turning point for boosting the yen. They said in their report, "The Bank of Japan must show more confidence, indicating the need for further tightening of policy, to trigger a stronger yen."

Mitsubishi UFJ currently expects the Bank of Japan to raise rates only once more in the fourth quarter of this year, and anticipates the US dollar against the yen to decline in the second half of this year, but this would also require the Federal Reserve to lower interest rates to near 4.00%.

Furthermore, any significant movement in the yen will be largely restrained by expectations for the Federal Reserve's meeting later this week. Analysts at ING Group wrote in a report:

"The yen is struggling and may be affected by the 'buy the rumor, sell the fact' effect. Meanwhile, we have repeatedly emphasized that a sustainable rebound in the yen depends more on a decrease in US interest rates, rather than rate hikes by the Bank of Japan."