The Bank of Japan (BOJ) held rates steady Thursday, sending the yen sharply higher and sparking speculation on whether policymakers would intervene to halt the currency's rise.
At the end of a two-day monetary policy review, the BOJ said it will continue to conduct money market operations so the monetary base increases at an annual pace of 80 trillion yen ($760 billion) and maintain a negative interest rate of minus 0.1 percent to the policy-rate balances in current accounts held by financial institutions at the bank.
While the BOJ's decision was widely anticipated, the yen still strengthened more than 1 percent against the dollar, hitting a 21-month high of 104.5, while Nikkei stock futures in Chicago and Osaka dropped more than 1 percent. The currency has already rallied 13.5 percent year to date against the greenback, inflicting pain on the export-focused companies listed on Japan's benchmark equity index.
"It is really interesting when you get a flat decision out of a central bank and you see these big market swings. This makes investing more difficult for investors," noted Macquarie division director Martin Lakos.
Should market turbulence continue, that could force officials to step in.
"Policymakers actually spend more time looking at equity markets than the actual yen, and if it does have a significantly negative impact on stocks, intervention risks picks up," said Mitul Kotecha, head of Asia FX and rates strategy at Barclays.
Ahead of the decision, HSBC predicted that policy inaction could cause unwanted currency gains.
If the BOJ abstained from stimulus on Thursday, that could weigh on market confidence in the central bank's commitment to increasing inflation, potentially translating into a stronger currency and making the BOJ's job even more difficult, Izumi Devalier, economist at HSBC, explained in a recent note.
"In our view, the longer the board waits to address downside risks to the economy and prices, the more markets will question the central bank's commitment towards its inflation target," she continued.
April's consumer price inflation (CPI) report — the latest available— showed a 0.3 percent annual fall, the second straight month of decline and a far cry from the BOJ's goal of 2 percent inflation by early 2018.
In its official statement on Thursday, the BOJ repeated that the economy continued "its moderate recovery trend," citing steady improvement in business fixed investment, employment and housing investment.
It did acknowledge recent weak developments in private consumption and flat industrial production however, and expected annual change in CPI to be zero percent for the time being as energy prices extend their slide.
The central bank has kept its powder dry since the shock-and-awe introduction of negative rates in January, and the majority of market participants had expected that trend to continue this month, pointing to the upcoming U.K. Brexit referendum as a key reason. Britain votes on June 23 on whether to will stay in or leave the European Union and market upheaval caused by a Brexit could spark further yen appreciation.
"The BOJ are in a pickle and more than most will be really hoping that the UK don't vote to 'leave' or USD/JPY will be trading below 100 yen and they will have to do something amazingly punchy just to stabilize assets," explained Chris Weston, chief market strategist at IG.
"On the other hand, even if the UK vote to remain and risk assets undergo some sort of relief rally, domestic inflation expectations shouldn't pick up greatly and they [BOJ] may need to ease in this scenario anyhow."
On Wednesday, Reuters reported the BOJ had a contingency plan if Britain did leave, one that involves the central bank offering dollar funds to Japanese banks should investors rush to buy the U.S. currency in a flight to safety.
Analysts now expect the central bank to take action in July as officials wait to assess the market implications from the June 23 vote.
"One suspects that we will head into the July meeting with expectations of additional Japanese government bond (JGB) and exchange traded fund (ETF) purchases sky high. The next two weeks promises to be very interesting indeed," said Weston.