Japan's Nikkei 225 Index faced significant declines for the second consecutive day on Friday, as traders brace for further tightening of the country's monetary policy. The Nikkei 225 plunged by 4.5% on Friday, adding to a global stock market slump that began following disappointing economic data from the United States. This drop follows a 2.5% fall the day before, bringing the index closer to its lowest point since February.

The Bank of Japan (BOJ) raised its interest rate by 15 basis points to 0.25% on Wednesday. This move, the second rate hike of the year, also included plans to gradually reduce its bond-buying program. This adjustment marks a significant shift in the BOJ's monetary policy, which has relied heavily on debt purchases for over a decade. Traders are now anticipating further rate increases later this year.

Ken Cheung, Director of Foreign Exchange Strategy at Mizuho Securities, noted, “The BOJ's unexpected 15-basis point rate hike signals a hawkish shift. The BOJ also highlighted inflation risks and indicated the possibility of additional rate hikes.”

The interest rate increase has narrowed the gap between US and Japanese rates, boosting the Japanese yen against the US dollar. The yen's value has risen, with the dollar dropping over 4% against the yen since mid-July. On Friday, the dollar slightly recovered, gaining 0.1% to 149.57 yen.

Frank Benzimra, Head of Asia Equity Strategy at Societe Generale, warned that the increased volatility of the yen poses risks to Japan’s decade-long equity bull market. A strong yen could negatively impact profits for Japanese exporters.

Over the past four years, the yen has weakened significantly, falling 40% against the US dollar and 30% against the euro. The weak yen, combined with strong corporate earnings and effective governance reforms, had driven the Nikkei 225 to record highs this year. However, the yen’s recent appreciation has led to a 12% decline in the Nikkei since July 12.

Despite the current challenges, Citi analysts remain optimistic about Japanese stocks in the long term, citing rising inflation and a positive wage-price spiral. They believe these factors could help Japan overcome years of economic stagnation.

In broader Asian markets on Friday, declines were widespread: South Korea’s Kospi fell 3.3%, Australia’s S&P/ASX 200 dropped 2.3%, Hong Kong’s Hang Seng Index lost 2.1%, and China’s Shanghai Composite decreased by 0.5%.

In the US, Wall Street also experienced losses. The Dow Jones Industrial Average fell by 1.2%, while the S&P 500 lost 1.4%, and the Nasdaq Composite dropped 2.3%. Investors are closely monitoring the job market for signs of a soft economic landing, where inflation moderates without triggering a recession. Recent data showed a rise in first-time jobless claims to 249,000, the highest since last August, and continuing claims increased to 1.877 million, the highest since November 2021.

The Federal Reserve has hinted at a possible rate cut in September, offering some hope for a shift in the economic landscape.

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