FAT CATS

[lady*b]

February 21, 2007
The Bank of Japan (BoJ) opted last night to hike its main policy rate by 25 basis points to 0.50%. Despite concerns among some investors that rising rates in Japan will cause so-called yen carry trades to "blow up", financial markets have taken the announcement very much in stride.

Indeed, the yen has weakened versus most currencies in the aftermath of the rate hike, and other Japanese financial prices have shown little reaction to the news. The yield on the bellwether 10-year Japanese government bond closed 1 basis point lower last night, and the Nikkei stock index was little changed. The lack of response to the BoJ rate hike likely reflects investor expectations that further tightening by the BoJ will occur at a very gradual pace. Indeed, the BoJ noted in its press release that it "will adjust the level of interest rates gradually in the light of developments in economic activity and prices, while maintaining the accommodative financial conditions ensuing from very low interest rates for some time." The Japanese yield curve is priced for another 25 basis point rate hike by the end of the year, a pace of tightening that, if realized, should have very little effect on the Japanese economy, let alone the global economy.

Speaking of rate hikes, attention now turns to U.S. CPI data for January, which will be released this morning at 8:30 EST. The consensus forecast looks for a 0.1% monthly increase in the "headline" and a 0.2% rise in the "core." Larger-than-expected increases, especially in the "core", could lead some investors to conclude the Fed will need to resume tightening later this year, an outturn that could cause the dollar to strengthen versus most major currencies. On the other hand, smaller-than-expected increases would reinforce expectations the Fed will be on hold for the foreseeable future, which could weigh somewhat on the dollar later today.

Jay H. Bryson, Global Economist
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Corporate & Investment Banking
Currency Risk Management
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