Should we expect a Japanese rate hike?

With Japan enjoying its longest unbroken period of growth since WW2, speculation over a base rate hike is rife. So are rates likely to rise? And, if they do, what will be the impact on the carry trade and the Yen?

As if to confirm the Asian region's economic strength, Japan's economy grew by an annualised 2% over Q3, confirming the country's longest unbroken period of economic expansion since World War 2. Not only was the Q3 2006 outturn stronger than expected, but it built on an upwardly revised 1.5% for Q2 (previously 1.0%). Not only does the data leave Japan on track for 2.5% growth over 2006 and 2007 but, perhaps more importantly, it leaves the way clear, despite some political opposition, for the Bank of Japan to raise the Official Discount Rate (Base Rate) from just 0.25% (itself a hike from 0.0 on 14th July this year) on December 18th-19th, in the wake of the quarterly Tankan Survey. Given that recent comments from the Bank of Japan governor, Toshihiko Fukui, indicate that base rates at prevailing levels are unsustainable there had been some discussion about the possibility of an even earlier rate hike. The significance of all this lies in the possibility that Japanese base rates have much further to rise than the markets are currently pricing in. The question is whether the economy is robust enough to sustain base rates of c 2.5% and what might happen to the much vaunted "carry trade" were rates to reach those levels.

Japanese interest rates: what a rate hike would mean for the Yen

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