The Bank of Japan raised its short-term policy rate to around 1.0% on June 16, lifting the country’s benchmark borrowing cost into territory not seen since the mid-1990s. The central bank also raised the rate applied to its complementary deposit facility to 1.0% and its basic loan rate to 1.25%, with the changes taking effect June 17.
That is still a low rate by global standards. The Federal Reserve was expected this week to keep US rates at 3.50% to 3.75%, according to Reuters, leaving investors with a sizable yield gap between Japan and the US.
For years, the yen has been the market’s preferred low-cost liability. Investors could borrow in yen, sell yen, and use the proceeds to buy higher-yielding assets. The return depended on the yield spread staying attractive and the yen not rallying hard enough to wipe out the income advantage.
That trade has not disappeared. It has become more conditional.
The BOJ is now charging more for the liability side of the position while also warning that inflation pressure may require more tightening. That changes the risk profile. So while a yen-funded trade can still work at 1%, it just has less room for error if the yen moves sharply, volatility rises, or the BOJ signals another step higher.
Yen pressure
The unusual part of the decision is that Japan raised rates while the yen remained under pressure.
Reuters reported the yen traded around 160 per dollar after the decision, leaving the currency close to levels that have kept markets alert to the risk of official support. Japan’s Ministry of Finance spent ¥11.7 trillion, or about $73.12 billion, supporting the yen after it weakened past 160 per dollar in April.
The central bank’s own statement focused on that pass-through risk. It said crude-oil-related price increases had been passed through to business-to-business prices at a relatively fast pace, and that this could spread more broadly into consumer prices.
This is a reversal of Japan’s old problem. The BOJ spent years trying to generate durable inflation. It is now trying to stop imported cost pressure, wage gains, and a soft currency from turning the 2% target into a ceiling breach rather than a goal.
CFTC data showed leveraged funds and asset managers remained heavily short yen futures in early June. In addition, BIS research on the August 2024 market turbulence found that FX carry trades were hit hard when deleveraging pressures spread through markets. The BIS said the overall size of the trade was difficult to measure, but noted the yen’s central role as a funding currency and the speed with which leveraged positions can amplify a market move.
The 2026 setup is not a replay of August 2024. The policy move was expected, the BOJ did not pair the hike with an aggressive bond-market shock, and US rate differentials still favor carry. But the lesson from 2024 remains relevant: the risk in a crowded funding trade usually appears at the exit, not at the entry.
Cushioning bonds
The BOJ did not deliver a pure tightening shock. Reuters reported the central bank decided to pause its bond taper plan from April 2027 and continue buying about ¥2 trillion, or roughly $12.5 billion, of Japanese government bonds per month.
While the front end of Japan’s rate structure is moving higher, the BOJ is still trying to avoid an abrupt repricing of longer-term government debt.
The strategy is delicate. Japan wants to tell markets that inflation risk is real without convincing them that decades of cheap funding are ending overnight.
The BOJ’s rate is not high enough to erase the carry trade by itself. The US-Japan rate gap remains meaningful, and a weak yen can still reward investors who fund in Japan and hold assets elsewhere.
The bigger change is psychological and mechanical. Japan’s funding rate now has a one-handle. The BOJ has said further hikes remain possible if economic and price conditions evolve as expected. The yen remains weak enough to keep inflation and intervention risk alive.
A year ago, yen-funded trades could lean on the assumption that Japan would remain the outlier among major central banks. After this move, the trade has to price something different: Japan may still be cheap, but it is no longer static.
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