What does the Bank of Japan increasing its interest rate from .25% to .5% mean and why is it causing panic in the markets?

Question

I’m no good at economics lol

In: 4812

Answer 1

The rise in borrowing costs has been mentioned which is true, but it also represents a bit of a paradigm shift that was a surprise to markets.

The Japanese central bank had been keeping rates effectively zero whilst other central banks had been rising to manage inflation. Japan has not seen the same inflation as most other markets, for a number of reasons. Japan’s monetary policy remains very accommodative, but this is a move in the opposite direction, albeit somewhat marginal.

The break in rhetoric from the Bank of Japan caught market participants but surprise and markets reacted accordingly; bonds fell to adjust to the new rate regime expectations, equity markets overall fell, financial stocks rose, and the Yen rallied. The Australian stock market fell sharply as a flow on effect – there is a common trade (“carry trade”) whereby you borrow in Japan cheaply to invest in higher yielding markets like Australia. The rise in rates makes this less attractive, especially if there is more of this to come. Investors therefore would have closed out their higher yield paying offshore “long” positions and their “short” Yen position which was the cheap borrowing leg.