Disagreement over the Japanese Yen exchange rate forecast: Can the central bank's interest rate hike reverse the downward trend?

The Bank of Japan announced a 0.25 percentage point rate hike on December 19, bringing the policy interest rate to 0.75%, the highest in nearly 30 years. However, the market’s reaction was somewhat “uncooperative”—the yen did not strengthen due to the tightening policy; instead, the USD/JPY exchange rate continued to rise. What signals are hidden behind this phenomenon?

Policy implementation, but the market remains unconvinced

Governor Ueda Kazuo’s cautious wording at the press conference became the key factor in market disappointment. Although the central bank reiterated that it would continue to raise rates when economic and price outlooks meet expectations, Ueda did not provide a clear timetable for the next step or the magnitude of future hikes.

Especially regarding the neutral interest rate level (1.0%~2.5%), the central bank stated that it is “difficult to determine in advance” and plans to gradually revise its estimates later. This vague stance led the market to believe that the central bank’s policy path still has uncertainties, and hawkish expectations have thus been shattered.

Interest rate differential dilemma suppresses the yen

ANZ Bank strategist Felix Ryan pointed out the core issue: although the central bank has started a rate hike cycle, the USD/JPY exchange rate is rising against the trend. This indicates that the market lacks confidence in the Bank of Japan’s future rate hike pace.

Deeper reasons lie in the interest rate differential pattern. The Federal Reserve remains in an easing cycle, while the Bank of Japan is raising rates but at a noticeably slower pace, resulting in a widening interest rate gap that is unfavorable to the yen. The bank expects that even if the BOJ continues to raise rates through 2026, the yen will still weaken relative to the dollar over the next year. ANZ Bank forecasts the USD/JPY rate will reach 153 by the end of 2026.

Divergence among institutions: When is a true hawkish stance?

There are differing forecasts regarding the yen exchange rate. State Street Global Advisors maintains a long-term target of 135-140 for USD/JPY, believing that the Fed’s easing policy supports the dollar, while Japanese investors increasing their FX hedging ratios also suppress the yen’s rise.

The overnight index swap market shows that investors expect the BOJ to raise rates further to 1.00% by Q3 2026. However, Nomura Securities believes this is not hawkish enough. Only if the central bank signals that the next rate hike could be brought forward to around April 2026 will the market truly buy into the yen. Without a significant upward revision of the neutral rate estimate, mere verbal commitments are unlikely to change market perceptions of long-term terminal rates.

Key point: Guidance over statements

The current situation reflects a reality: the key to USD/JPY forecasts is not whether rate hikes have already occurred, but whether future policy paths are clear. Governor Ueda needs to provide clearer guidance on the neutral rate estimates and the timetable for rate hikes in subsequent communications, so as to truly reverse the market’s pessimistic outlook on the yen.

In the short term, yen exchange rate fluctuations may continue until the central bank issues the “truly hawkish” signals that the market desires.