Markets are still looking to extend carry trades on yield grounds, but extreme caution is required given the longer-term capital account trends. The dollar offers… … very little value above 121.0

The yen was generally on the defensive on Tuesday ahead of the interest rate decision. In the event, the Bank
of Japan increased interest rates by 0.25% to 0.50%, the highest level for 10
years. The yen strengthened after the decision, but was unable to sustain the
gains and weakened back to 120.50 against the dollar from highs of 119.70.

The central bank maintained an unchanged view on the economy, although there was an upgrading of consumer
spending forecasts. The Bank of Japan stated that further adjustments to
interest rates will be made gradually and there will be expectations that the
next increase will be delayed for several months. The level of nominal interest
rates will maintain global interest in carry trades and yen selling, especially
with markets looking to a period of stability in rates. The government did not
openly criticise the decision, but emphasised the fact that the Bank of Japan
should support growth conditions

There will, however, be greater caution over carry trades and longer-term capital flows are likely to be more
yen supportive over the next few weeks. The main feature is liable to be a
sustained increase in yen volatility levels.

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