BOJ Raises Rates to 31-Year High of 1.25%, Yen Weakens as Carry Trade Hits $2.3 Trillion

The Bank of Japan raised its policy rate to 1.25% on Sept. 29, 2026, a 31-year high, yet the yen weakened past 158 per dollar as the Federal Reserve's renewed tightening kept the US-Japan rate gap wide. The BOJ's 7-2 vote fell short of market expectations for a more hawkish stance. Cross-border yen borrowing has surged 67% over three and a half years to 360 trillion yen ($2.3 trillion), fueling carry trades into higher-yielding US assets. UBS Asset Management's Kevin Zhao said he would sell yen into any intervention, noting the Fed is also expected to hike three times by June 2027. The BOJ faces a dilemma: slow hikes expand carry trades, while rapid hikes risk a disorderly unwind. When the BOJ surprised markets in summer 2024, the Nikkei fell 12.4% in a single day. UBS strategist James Malcolm estimated that carry trade peaked at $500 billion, with roughly $200 billion unwound in two to three weeks. He said the speed of rate-gap changes, not its absolute level, drives liquidation.