The Bank of Japan, which some investment institutions believe was the initiator of the global stock market crash on "Black Monday" in August, announced on Friday that it would maintain its basic interest rate and keep its monetary policy stable. This move further indicates that after the unexpected rate hike and hawkish views scared investors in July, the central bank believed that there was no need to rush to raise interest rates and emphasized that it was monitoring the financial markets. Following the unexpected 0.5 percentage point rate cut by the Federal Reserve to start an easing cycle, global stock markets rebounded significantly under the expectation of Fed easing. The Bank of Japan's decision to keep its policy unchanged, as well as the indication that it will not rush to further tighten monetary policy after the unexpected rate hike in July, undoubtedly provided a strong boost to global stock markets.

The immediate reaction in the foreign exchange market was relatively subdued, with the yen experiencing relatively small fluctuations, but global stock markets continued to rebound, and the Japanese stock market continued to rise sharply, while the benchmark Japanese bond yield remained stable. Overall, after the unexpected rate hike in July triggered the "yen carry trade unwinding shock" and caused a global stock market crash, the Bank of Japan is expected to keep the uncollateralized overnight call rate around 0.25% at its policy meeting in September, which is in line with economists' expectations.

In addition, the Bank of Japan raised its assessment of consumer spending, which is the key engine of economic growth in Japan, and pointed out the need to monitor global financial markets. The Bank of Japan reiterated that it expects price growth to be in line with its target in the latter half of the forecast period, indicating that the central bank is still on the path of raising interest rates. However, after witnessing "Black Monday," the Bank of Japan's board members may adjust their pace forward based on the situation in the financial markets.

The culprit behind the global stock market crash on "Black Monday": Forced large-scale liquidation of arbitrage trades.

Due to the perception that the tightening of monetary policy by the Bank of Japan at the end of July caused a historic stock market crash in Japan and led to global market turmoil, the central bank is now facing significant market pressure.

The Japanese stock market led the global stock market crash on "Black Monday" in August. The main reasons were the unexpected increase in the unemployment rate, which fueled expectations of a recession in the US economy, the rapid appreciation of the yen exchange rate driven by the Bank of Japan's hawkish rate hike, which forced the quick liquidation of arbitrage trades, and investors' concerns that further rate hikes by the Bank of Japan could harm Japan's fragile economic recovery and the appreciation of the yen, which would hit major exporters such as Toyota. As a result, the Japanese stock market experienced multiple circuit breakers and triggered a global stock market collapse on Monday.

The rapid appreciation of the Japanese yen prompted traders to quickly unwind the once popular yen-funded arbitrage trade position in the global forex market, forcing some traders to sell a large number of highly liquid Japanese stocks, U.S. tech stocks, and other profitable stock positions to offset the huge losses caused by borrowing yen, leading to a brutal vicious cycle of selling risk assets in the entire financial market on Monday.

As a result, the risk of this arbitrage trade significantly increases when the Japanese yen appreciates rapidly. Because they borrowed in yen, leverage forex traders must buy back the yen at a higher price to repay the loan when the yen appreciates, often resulting in a significant reduction in their actual returns, and even potentially leading to large losses.

The prospect of a rate hike by the Bank of Japan is difficult to shake, but the policy pace may be slower.

On July 31, BoJ Governor Haruhiko Kuroda explicitly expressed a hawkish inclination, which was believed to trigger a global market crash in early August. Subsequently, BoJ committee members quickly released dovish remarks to ease the market's expectations of a rate hike by the Bank of Japan.

Although the BoJ monetary policy committee members have shown their firm intention to raise interest rates, that is, to continue to implement a normalization of interest rate policy when the data allows, in recent days they have also frequently emphasized the need to temporarily monitor financial markets and their impact on the global economy.

"If the October outlook report shows that the Bank of Japan is moving toward its price stability target, and the global financial environment is stable, they still plan to raise rates at that time or in December," said Toru Suehiro, Chief Economist at Daiwa Securities. "Kuroda will reiterate the same neutral stance at the press conference, that is, if the price outlook is realized, he will choose to raise interest rates."

Market pricing indicates that investors are not as confident as economists that the Bank of Japan will take action again before the end of the year. Overnight index swaps suggest that there is only a 33% chance of a 25 basis point increase in the policy rate by the Bank of Japan this year.

The Bank of Japan mentioned in its policy statement that if the economic and financial outlook is realized, it will continue to take a stance of raising policy interest rates. The central bank used this phrase in July to explain its rate hike decision and policy direction. The central bank also stated that medium- to long-term inflation expectations may increase.

"Governor Uchida may consider two main factors - the risk of massive market volatility caused by the hawkish Bank of Japan, and the increasing confidence in achieving its 2% inflation target supported by recent wage and price data. Our fundamental view is that Governor Uchida will send a subtle signal indicating that if all conditions are right, the Bank of Japan will be ready to raise interest rates in October." said Taro Kimura, economist at Bloomberg Economics.

A few hours after the Federal Reserve's long-awaited policy shift and significant rate cut, the Bank of Japan's two-day committee meeting began. In the process, the Federal Reserve joined the ranks of major central banks in developed markets, including the Bank of England and the European Central Bank, in easing monetary policy. This process highlights the Bank of Japan's exceptional position as the only major central bank on a tightening path, and also hints at the possibility of the yen becoming the best-performing reserve currency in the Group of Ten in the coming year.

"I think the timing of the next rate hike will depend on the overseas economic situation in the next few months, especially the economic situation in the United States," said Chotaro Morita, Chief Strategist at All Nippon Asset Management. "I think this has largely delayed the Bank of Japan's policy decision."

With the Federal Reserve's actions on Wednesday strengthening the momentum of the global easing movement, there are differing views among observers of the Bank of Japan about the expected policy development trajectory in Japan.

The impact of the financial markets on the Japanese economy remains to be seen. Meanwhile, recent economic data has provided encouraging signs that the Bank of Japan will be able to raise interest rates on a larger scale based on wage growth and inflation stability. This explains why 53% of economists believe there is a risk of interest rate adjustments at the next meeting in October.

After the Liberal Democratic Party of Japan elects a new leader on September 27, Japan will welcome a new prime minister in the coming weeks. The party's dominant position in parliament virtually ensures that its leader will be appointed as the prime minister within days of the party's opinion poll. Insiders say that Bank of Japan board members expect the new leader not to push for drastic changes in monetary policy as the ruling party supports the central bank's pursuit of a stable inflation target.

Editor/ping