The Bank of Japan stands pat, giving a boost to the soaring global stock markets

According to the Zhitong Finance and Economics APP, the Bank of Japan, which some investment institutions believe to be the initiator of the global stock market crash in August, announced on Friday that it would maintain the basic interest rate and its monetary policy unchanged. This further indicates that after the unexpected rate hike and hawkish views in July scared investors, the central bank believes there is no need to rush to raise interest rates, and emphasizes that it is monitoring the financial markets. Following the unexpected 50 basis point rate cut by the Federal Reserve to start an easing cycle, global stock markets rebounded significantly on expectations of Fed easing. The Bank of Japan's decision to stay put, as well as the indication that it will not rush to tighten monetary policy further after the unexpected rate hike in July, undoubtedly provided a strong boost to global stock markets.

The immediate reaction in the foreign exchange market was relatively subdued, with the yen showing minimal volatility, but global stock markets continued to rebound, with the Japanese stock market continuing to rise significantly and the benchmark Japanese government bond yields remaining stable. Overall, after the July surprise rate hike triggered the "yen carry trade unwinding storm" and led to the global stock market crash, the Bank of Japan is expected to maintain the unsecured overnight call rate at around 0.25% at its policy meeting in September, which is in line with economists' expectations.

In addition, the Bank of Japan raised its assessment of Japanese consumer spending, which is a key engine of economic growth in Japan, and pointed out the need to monitor global financial markets. The Bank of Japan reiterated its expectation that price growth will align with its target in the latter half of the forecast period, indicating that the central bank is still on a path to raise interest rates. However, the Bank of Japan's board members may adjust the pace of progress based on the financial market situation following the events of "Black Monday".

The culprit of the global stock market "Black Monday": Forced massive unwinding of "carry trades"

Due to the perceived tightening of monetary policy by the Bank of Japan at the end of July, which seemed to trigger a historic plunge in the Japanese stock market and led to market turmoil globally, the central bank is currently facing significant market pressure.

The Japanese stock market led the global stock market crash on "Black Monday" in August, mainly due to expectations of a US economic recession heating up due to an unexpected rise in the unemployment rate, as well as hawkish rate hikes by the Bank of Japan pushing the yen exchange rate higher, prompting rapid unwinding of carry trades. Investors' concerns about further rate hikes by the Bank of Japan potentially harming Japan's fragile economic recovery and the yen's appreciation dealing a blow to major exporters like Toyota, led to the Japanese stock market plummeting on Monday, triggering multiple circuit breakers and causing a global stock market meltdown The rapid appreciation of the Japanese yen has prompted traders to quickly unwind the once popular yen funding arbitrage trading positions in the global foreign exchange market. This has forced some traders to sell a large amount of highly liquid stocks such as Japanese stocks and US technology stocks that have repeatedly hit new highs to offset the huge losses caused by borrowing yen, leading the entire financial market into a vicious cycle of selling risk assets on Monday.

Therefore, when the Japanese yen appreciates rapidly, the risk of this arbitrage trading significantly increases. Since they borrowed yen, if the yen appreciates, leveraged forex traders must buy back yen at a higher price to repay the loan, often resulting in a significant reduction in their actual returns, and even the possibility of large losses.

The prospect of a rate hike by the Bank of Japan is difficult to shake, but the pace of policy may be slower

On July 31, Bank of Japan Governor Haruhiko Kuroda clearly expressed a hawkish interest rate hike tendency, which was believed to trigger a global market crash in early August. Subsequently, members of the Bank of Japan's Policy Board quickly released dovish remarks to ease market expectations of a rate hike by the Bank of Japan.

Although members of the Bank of Japan's Policy Board have indicated their firm intention to raise interest rates, that is, to continue implementing a normalization of interest rate policy when conditions permit, they have also emphasized the need to temporarily monitor financial markets and their impact on the global economy.

"If the outlook report in October shows that the Bank of Japan is moving towards its price stability target and the global financial environment is stable, they still plan to raise rates at that time or in December," said Toru Suehiro, Chief Economist at Daiwa Securities. "Kuroda will reiterate the same neutral stance at the press conference, that is, if the price outlook is achieved, he will choose to raise rates."

Market pricing indicates that investors are not as confident as economists that the Bank of Japan will take action again before the end of the year. Overnight index swaps indicate that there is only a 33% chance of the Bank of Japan raising its policy rate by 25 basis points this year.

The Bank of Japan mentioned in its policy statement that if the outlook for economic and financial activities is realized, it will continue to take a stance of raising policy rates. The central bank used this phrase when explaining its rate hike decision and policy direction in July. The central bank also stated that medium- to long-term inflation expectations may rise.

"Kuroda will likely weigh two main factors - the risk of a hawkish Bank of Japan causing massive market turmoil, and the recent wage and price data supporting increasing confidence in achieving its 2% inflation target. Our basic view is that Kuroda will send a subtle signal indicating that if all conditions are right, the Bank of Japan will be prepared to raise rates in October," said Bloomberg Economics economist Taro Kimura.

Just hours after the long-awaited policy shift and significant rate cut by the Federal Reserve, the Bank of Japan's Policy Board meeting for two days began. During this process, the Federal Reserve joined the ranks of rate cuts by advanced market peers including the Bank of England and the European Central Bank, initiating a loose monetary policy cycle. This process highlights the Bank of Japan's exceptional position as the only major central bank on a rising interest rate trajectory, while also implying that the logic of the Japanese stock market may be different from the loose logic of mainstream advanced markets, and suggesting that the yen may become the best-performing sovereign currency among the G10 in the coming year

"I believe the timing of the next rate hike will depend on the overseas economic conditions in the coming months, especially the economic situation in the United States," said Chotaro Morita, Chief Strategist at All Nippon Asset Management. "I think this has significantly delayed the policy decisions of the Bank of Japan."

With the Federal Reserve's actions on Wednesday strengthening the momentum of global easing, there are diverging views among observers of the Bank of Japan on the expected policy development trajectory in Japan.

The impact of the financial markets on the Japanese economy is still to be observed. Meanwhile, recent economic data in the past few weeks has provided encouraging signs, indicating that the Bank of Japan may hike rates on a larger scale based on wage growth and stable inflation. This explains why 53% of economists see a risk of rate adjustment at the next meeting in October.

After the Liberal Democratic Party elects a new leader on September 27, Japan will welcome a new Prime Minister in the coming weeks. The party's dominant position in the parliament almost guarantees that the leader will be appointed as Japan's Prime Minister within days of the party's opinion polls. Informed sources suggest that Bank of Japan board members expect the new leader not to push for drastic changes in monetary policy, as the ruling party supports the central bank's pursuit of a stable inflation target