The US dollar climbed to its highest level in more than a year on Thursday after the Federal Reserve's decision to keep interest rates unchanged while adopting a hawkish tone fueled expectations for further rate increases. Although the dollar edged lower today, it remains close to that peak.

The US central bank left interest rates unchanged within a range of 3.50% to 3.75% at its first meeting under new Federal Reserve Chairman Kevin Warsh, who began his tenure with a broad policy review. Nearly half of Fed policymakers now expect interest rates to rise this year as concerns over inflation continue to grow.

According to data from the London Stock Exchange Group, the federal funds futures market is now fully pricing in an interest rate hike by October. Strong retail sales data has further reinforced expectations that monetary tightening will continue.

The US Dollar Index, which measures the currency against a basket of major peers including the yen, euro, and British pound, slipped 0.1% to 100.7 points. Despite the decline, the index remains near its highest level since May 2025.

Lee Hardman, Senior Currency Analyst at Mitsubishi UFJ Financial Group, said that "the Federal Reserve's hawkish policy update threatens to trigger a powerful rally in the US dollar."

He added that "the dollar has benefited from the sharp upward revision in short-term US interest rate expectations, more than offsetting the negative impact of the US-Iran agreement announced over the weekend."

Japanese yen

The Japanese yen weakened beyond the 161-per-dollar level late on Thursday, approaching its weakest point in four decades and reviving speculation that Tokyo could intervene again to support the currency.

After Japanese equity markets closed on Thursday, the yen fell sharply through the 161 level before extending losses later in the day to 161.80 per dollar, its weakest level since July 2024.

A move beyond 161.96 per dollar would push the yen to its weakest level since 1986.

Market speculation

The currency's decline prompted fresh warnings from Japanese financial officials. Reports indicated that Japanese Finance Minister Satsuki Katayama told a recent G7 meeting that Japan is "prepared to take decisive action against speculative movements" in foreign exchange markets.

The yen remains under pressure despite more than $70 billion in intervention by Japan's Ministry of Finance in May and recent interest rate hikes by the Bank of Japan, which have pushed borrowing costs to their highest level since 1995.

According to reports, Bank of Japan Deputy Governor Ryozo Himino told parliament that the central bank is closely monitoring currency movements because of their impact on the economy and inflation.

Analysts told CNBC that intervention efforts in the foreign exchange market have not been particularly effective in curbing yen weakness because the underlying drivers are structural in nature.

These factors include elevated US Treasury yields, which continue to support the dollar, as well as the pro-growth policies pursued by Japanese Prime Minister Sanae Takaichi's administration, which has signaled a preference for maintaining relatively accommodative monetary conditions.

While yen weakness has helped support Japan's exports and economic growth, it has also raised concerns about imported inflation and the erosion of household purchasing power.