The Bank of Japan (BoJ) has delivered a historic policy shift in early 2024, ending decades of ultra-loose monetary policy and moving away from negative interest rates for the first time in nearly two decades.

For years, the BoJ stood out as the lone dove among major central banks, keeping policy ultra-loose even as inflation surged worldwide. Now, with inflation finally taking root and signs of economic resilience emerging, its pivot toward normalization marks not only the end of an era — but the beginning of a new chapter for Japan and the global financial system.

From Ultra-Loose to Normalization

Since the 1990s, Japan has been synonymous with ultra-accommodative monetary policy. Following the collapse of its asset bubble, the country endured decades of stagnation, deflation, and weak growth. To fight these headwinds, the BoJ pioneered unconventional tools long before they became mainstream.

Negative interest rates, introduced in 2016, penalized banks for holding reserves and pushed borrowing costs to historic lows. Yield Curve Control (YCC) capped 10-year government bond yields, keeping funding ultra-cheap for both government and corporates. Alongside massive asset purchases, these measures aimed to reflate the economy.

Yet despite these efforts, inflation rarely approached the 2% target. Structural challenges — an aging population, sluggish wage growth, and weak consumption — kept demand subdued. By contrast, the Federal Reserve, European Central Bank, and Bank of England began tightening aggressively after 2021, widening the rate differential and driving sharp yen depreciation.

Why Now? Signs of Sustainable Inflation

Several forces finally convinced the BoJ it was time to act:

1. Inflation above target: Japan’s inflation has remained sustainably above 2% for the first time in decades, with core CPI hovering around 3% in recent months.
2. Wage growth: This year’s shunto wage negotiations delivered the strongest hikes in over 30 years, with major firms agreeing to increases above 4%. Sustained wage gains suggest demand-driven inflation rather than temporary cost shocks.
3. Corporate resilience: Companies have shown improved profitability and a greater willingness to pass costs on to consumers — a sharp contrast with deflation-era behavior.
4. Global context: Persistently wide interest rate differentials weakened the yen, raising import costs and fueling inflationary pressures. Staying behind the curve risked destabilizing currency markets.

Together, these developments signaled that maintaining negative rates was no longer appropriate — and may even distort the economy.

Market Reaction: From Yen to Bonds

The policy shift jolted global markets.

• The yen: The currency initially strengthened as traders priced in narrower yield differentials with U.S. Treasuries. The end of negative rates also threatened the viability of yen-funded “carry trades,” long a pillar of global liquidity.
• Japanese Government Bonds (JGBs): Yields jumped, with the 10-year benchmark hitting levels unseen since before YCC. With the BoJ stepping back from heavy bond buying, volatility could return to a market long shielded from it.
• Equities: Japanese exporters came under pressure as a stronger yen weighed on overseas earnings. In contrast, domestically focused firms and financial institutions may benefit from higher interest margins.

The immediate moves highlight how deeply BoJ policy has shaped global markets. For decades, Japan’s liquidity suppressed yields and fueled risk-taking abroad. Normalization is now forcing a recalibration.

Yen Weakness Persists — For Now

Despite the BoJ’s historic pivot, the yen has shown renewed weakness in recent months after the initial strong rally in late 2024, and the broad move in 2025 remains a huge swing. The reason lies in policy divergence: while the BoJ is moving cautiously toward normalization, the Federal Reserve has yet to cut rates. 

As a result, U.S.–Japan rate differentials remain wide, keeping upward pressure on the dollar and limiting yen gains.

That said, this may not last. If U.S. economic data weakens and the Fed begins its long-awaited rate-cut cycle while the BoJ continues its path of gradual tightening, the differential will narrow meaningfully. In such a scenario, the yen could regain strength, particularly if global investors unwind carry trades and repatriate capital to Japan.

Technical Outlook on USD/JPY

USD/JPY has staged a strong rebound following the Federal Reserve’s recent decision to hold rates. However, markets are now repricing the possibility that U.S. rate cuts could arrive sooner than expected, while the Bank of Japan has also hinted that another rate hike may come earlier than previously thought.

For now, uncertainty keeps the pair in a period of tight consolidation, likely extending into early September. Should investor expectations recalibrate — with markets leaning more firmly toward Fed easing and BoJ tightening — renewed selling pressure on USD/JPY could emerge.From a technical perspective, a decisive break below the 147.00 boundary would signal a shift in momentum and potentially open the door to a broader downtrend in the pair.

Outlook: End of the Carry Trades?

The BoJ’s exit from ultra-loose policy marks a turning point for global markets. For Japan, it is a long-overdue step toward normalizing financial conditions after decades of stagnation. For the world, it means higher funding costs, reduced liquidity, and the potential for significant shifts in currency and bond markets.

In the near term, yen weakness may persist as long as U.S.–Japan yield spreads remain wide. But the balance could shift rapidly once the Fed begins cutting rates and Japan’s domestic inflation and wage growth continue to hold up.

Investors should watch wage data, inflation trends, and global central bank decisions closely. Japan’s policy shift is not an isolated move — it is the start of a new chapter in the global monetary cycle.