The Bank of Japan and its policy — what moves the yen

On 19 March 2024 the Bank of Japan did something the market had waited seventeen years to see: it raised its policy rate above zero and abandoned the mechanism it had used for eight years to steer bond yields by hand. It was a quiet revolution. For the whole previous decade the central bank in Tokyo ran the most dovish policy among the majors, and the yen paid with weakness not seen in a generation. This article explains how that policy worked, why it moved USD/JPY so forcefully, and what changed in 2024.

Why the Bank of Japan was different from the rest

Most central banks did the same thing in recent years: when inflation rose, they raised rates, and the United States Federal Reserve (the Fed) pushed its rate above five percent in 2022 and 2023. The Bank of Japan (BoJ) went entirely the other way. For more than two decades it fought not inflation but its opposite — the persistent deflation and weak growth that have trailed the Japanese economy since its asset bubble burst in the early 1990s.

That opposite diagnosis forced an opposite remedy. Rather than cooling the economy, the BoJ tried to warm it: it held the policy rate at minus 0.1 percent, bought government bonds on an enormous scale, and did something no other major central bank used at the time — it directly controlled the price of long-term debt. That combination made Japanese policy a reference point for global capital flows.

Yield curve control and negative rates

The most unusual element was yield curve control, introduced in September 2016. Normally a central bank sets a short-term rate and lets the market price longer-dated bonds. The BoJ took over that second part too: it announced that the yield on ten-year Japanese government bonds would stay near zero, and committed to buying them in whatever size was needed if the yield tried to rise above its set band.

The effect was twofold. Long-term borrowing costs in Japan were glued to zero, while United States bonds paid four, then five percent a year; and the bank bought so many securities that genuine market pricing of Japanese debt all but disappeared. Together with the negative policy rate, this painted an economy in which holding yen simply did not pay — so capital flowed to where the return was real.

How the rate gap weakened the yen

Here we reach the heart of the matter, which every trader in yen pairs must grasp. USD/JPY is governed not by Japanese or United States rates alone, but by the difference between them. When the Fed raised rates aggressively in 2022 while the BoJ held near zero, that gap widened sharply, and an investor who could earn close to five percent on United States bonds or almost nothing on Japanese ones faced an easy choice: sell yen, buy dollars.

Japanese institutions did the same. The country's pension funds, life insurers and banks have for years shipped capital abroad for higher yield they cannot find at home, and these flows form a structural pressure on the yen to weaken. USD/JPY, near 115 in early 2022, broke through 150 and in 2024 reached above 160 — the weakest yen in decades. This was not panic but the logical consequence of a policy in which one side paid for money and the other gave it away free.

Interventions by the Ministry of Finance

When USD/JPY rose too fast, the Japanese Ministry of Finance stepped in. The ministry, not the BoJ itself, decides on currency interventions in Japan — the central bank only carries out the operation. In 2022, for the first time in a quarter of a century, it began selling dollars and buying yen to halt the slide in its own currency; for decades before that, Japan had intervened only in the other direction, selling yen to weaken it for exporters.

In 2022, and again in 2024, such operations reached around nine trillion yen each and could pull the rate down by several hundred pips within minutes. The trouble is that as long as the rate gap still favoured a weak yen, the effect was short-lived — after the first wave the rate often climbed back toward its earlier highs. An intervention smooths excessive volatility, but on its own it does not reverse the trend.

The 2024 turn and the Ueda era

Everything began to change when Kazuo Ueda, an economist from the University of Tokyo, took the helm in April 2023. Inflation had finally cleared the two percent target on a lasting basis, which gave the bank the argument to back cautiously out of the experiment. In March 2024 the BoJ ended the era of negative rates, lifting them for the first time in seventeen years, and abandoned yield curve control at the same time. A few months later it added another hike.

"The negative interest rate policy and the other extraordinary measures have fulfilled their roles." — Kazuo Ueda, Governor of the Bank of Japan, 2024.

The normalisation is slow, though, and not for lack of nerve. A bank that spent years buying bonds worth more than the economy's entire annual output cannot make abrupt moves without risking the debt market and its own balance sheet, so Ueda's communication is always cautious and hedged. For a trader, every further hike, however small, carries real weight, because it narrows the rate gap with the United States. How that gap fits the wider picture of central banks I cover in the article on watching the Fed, ECB and BoJ, while the divergence itself is broken down in the piece on Federal Reserve decisions.

The carry trade and the risk of a sudden unwind

The extreme rate gap gave birth to the best-known strategy tied to the yen, the carry trade. It works by borrowing capital in a low-rate currency and placing it in a higher-rate one, to earn on the rate gap alone, regardless of how the exchange rate moves. For years the yen was ideal for this: borrowed almost free and used to buy higher-yielding dollar assets, it delivered a steady income as long as USD/JPY rose or stood still.

The trap is that the yen is also a safe haven. When fear hits the markets, capital flees toward it and investors buy back yen to repay their loans, which triggers an avalanche of closing positions that can make USD/JPY collapse. In the summer of 2024, when the BoJ surprised with a hike while easier-policy signals emerged in the United States, exactly such an unwind took place — months of accumulated profit evaporated in a few sessions. I lay out the mechanics in the article on the carry trade on USD/JPY, and the term is defined in the carry trade glossary entry.

What now

1. Add the rate gap to your desktop. Open a chart of the yield on ten-year United States and Japanese bonds and place it beside the USD/JPY chart for a week. You will see the rate reacting to the widening and narrowing of that gap before it reacts to the headlines.
2. Note the Bank of Japan meeting dates in your calendar. The bank decides on policy eight times a year, and after March 2024 every meeting can bring a shift in stance. Remember that the governor's press conference often matters more than the statement, because that is where the tone for coming months is set.
3. Check how the yen behaves on days of strong market fear. Go back to sessions with a sharp drop in equity indices and see how USD/JPY moved then. You will understand why a position built on the rate gap carries the risk of a sudden unwind, and it will not catch you off guard.
4. Compare the yen with a pair you already know well. Pick a major pair you trade often and put its recent volatility next to that of USD/JPY around the 2024 highs and the summer unwind. The difference in temperament shows how a funding currency behaves under stress.