Bank of Japan December decision window opens: The real battle begins after a 0.75% rate hike

The Bank of Japan is set to announce its interest rate decision on December 19th. This is not just a numbers game but a critical moment that influences global capital flows. The market widely expects a 25 basis point hike to 0.75%, which would mark the highest level in Japan in nearly 30 years. However, the real market divergence lies in the wording of Governor Ueda and his stance on the future policy path.

Rate hike has already been priced in; policy outlook is the key to victory

The decision to raise interest rates is no longer a suspense—market focus has shifted from “whether to hike” to “when to hike.” Most institutional research indicates that the Bank of Japan is reassessing the natural rate and is likely to raise the lower bound of its neutral rate estimate (from the current 1.0%), which is a significant change.

Based on market pricing, investors are now betting that rates will rise to 1.0% before September 2026. Nomura Securities warns that this expectation may be overly aggressive, reflecting an excessive spread of hawkish sentiment. In other words, the market might be overestimating the BOJ’s determination to hike.

The true power of the unwind wave of carry trades

The most direct impact of Japan’s rate hike is the unraveling of carry trades. The logic of this trade is simple: borrow cheap yen and invest in high-yield assets like the US dollar or other assets. Once yen appreciation expectations materialize, carry trades will be massively unwound, with large amounts of capital withdrawing from high-risk assets such as US stocks and cryptocurrencies.

The scene from late July 2024 is still vivid: the BOJ unexpectedly raised rates to 0.25%, directly triggering a reverse unwind of carry trades, causing the yen to surge and US stocks and Bitcoin to fall sharply. This time, the rate hike is larger, and theoretically, the impact should be even stronger.

But this time is different. Analysts point out that since rate hike expectations have been fully digested by the market and the Japanese government is still implementing large-scale fiscal stimulus measures to hedge, the upward pressure on the yen may not be as intense as expected.

Yen appreciation or depreciation, the future of USD/JPY depends on it

Regarding the future trend of the USD/JPY exchange rate, institutions present two starkly different scenarios.

“Dovish rate hike” scenario: US banks believe that if the BOJ’s wording remains relatively dovish, implying a slow pace of rate hikes, USD/JPY could stay high or even move toward 160.

“Hawkish rate hike” scenario: If the BOJ signals a tough stance (“hawkish”), the short covering of carry trades will accelerate, and USD/JPY could fall back toward 150. However, US banks consider this less likely.

The US bank’s target USD/JPY prices for 2026 are: Q1 at 160, Q2 at 158, Q3 at 156, and Q4 at 155. Nomura Securities is more optimistic about yen appreciation, forecasting the currency pair to decline quarter by quarter in 2026: 155→150→145→140, reflecting an expectation that yen depreciation pressures will continue to ease.

The domino effect on global exchange rates

It is worth noting that yen appreciation or depreciation will not only impact the US dollar but also resonate across emerging market currencies worldwide. For example, when the US dollar is under pressure, emerging market currencies like the Philippine peso often get a breather. The BOJ’s policy stance is becoming a driving force in the global currency reshuffle.

Final warning

This rate hike drama is not just about the 25 basis points itself but about the market re-pricing the future policy path. Investors need to closely monitor subtle adjustments in the central bank’s language regarding “neutral interest rate” and “terminal rate,” as these are the real signals that can change market expectations.