Bank of Japan Considers Raising Interest Rate to 1.25% in September, Raising Fears of Yen Carry Trade Collapse

Reliable reports indicate that the Bank of Japan is considering raising its key interest rate to 1.25% at the upcoming monetary policy meeting on September 18, in a move that represents a continuation of the monetary normalization path the bank initiated after decades of zero and negative interest rate policy.

This prospect has sparked a wave of anxiety in global financial markets over what is known as the yen carry trade—a strategy where investors borrow in the low-yielding Japanese currency and invest those funds in higher-yielding assets in other countries. If Japanese interest rates rise, these trades unwind, forcing investors to rapidly liquidate their positions.

The yen carry trade previously caused widespread turmoil in global stock markets in August 2024 when the Bank of Japan unexpectedly raised interest rates, triggering sharp sell-offs across Asian, European, and American markets that lasted for days.

Gulf investors and sovereign wealth funds allocate a portion of their international investment portfolios while implicitly relying on the stability of Japanese interest rates; a rate hike redefines the funding balances within these portfolios. Global market experts believe that the Bank of Japan's decision will serve as a test of monetary resilience in emerging markets, as a partial collapse of the yen carry trade could lead to cascading selling pressures affecting assets unrelated to Japan.

What do these terms mean?

Currency Carry Trade: An investment strategy in which an investor borrows in a low-interest currency like the Japanese yen and invests the amount in higher-yielding assets in other countries, such as the Australian dollar or US bonds, benefiting from the yield spread while desiring currency stability.

Zero Interest Rate Policy (ZIRP): An unconventional monetary policy that Japan relied on for decades, keeping interest rates at or near zero to stimulate borrowing and spending and break the deflationary cycle. Under this policy, the yen became the preferred currency for funding international speculative trades.

Monetary Policy Normalization: The gradual transition of a central bank away from unconventional emergency policies, such as zero interest rates or quantitative easing, toward interest rate levels closer to normal historical rates that reflect the actual state of the economy.