The Bank of Japan raises interest rates but cannot save the yen. Why is the USD/JPY exchange rate rising against the trend?

A fascinating paradox has emerged in the market: the Bank of Japan is tightening policy, yet the yen is depreciating.

On December 19, the Bank of Japan announced a 25 basis point rate hike as scheduled, raising the benchmark interest rate to 0.75%, the highest level since 1995. Normally, a rate hike should increase the attractiveness of the yen, but the opposite happened—the USD/JPY exchange rate not only failed to fall but actually rose.

What exactly is happening behind the scenes? The answer may lie in market expectations for the central bank’s future policy.

Governor Ueda Haruhiko’s comments at the press conference were somewhat vague. He did not provide a clear timetable for the next rate hike, only mentioning that it is difficult to determine the neutral interest rate level in advance (currently between 1.0% and 2.5%) and that adjustments will be made if necessary. Such language is seen as not hawkish enough by the market and could be interpreted as “not rushing to raise rates further for now.”

ANZ Bank strategist Felix Ryan believes that the reason the market has not heavily bought into the yen is precisely due to the lack of clear guidance on the pace of future rate hikes by the BOJ. He expects the USD/JPY exchange rate to remain around 153 by the end of 2026, as interest rate differentials still do not favor the yen. He states that although the market expects the BOJ to continue raising rates in 2026, this is not enough to reverse the yen’s suppressed position.

Fidelity Investment Management shares a similar view. Strategist Masahiko Loo pointed out that the market might interpret this rate hike as a dovish signal, causing short-term volatility in the yen. The firm maintains a long-term target of 135-140 for USD/JPY, believing that the Fed’s easing policies and Japanese investors increasing their foreign exchange hedging ratios will continue to support the dollar.

From market expectations, overnight index swaps (OIS) indicate that investors believe the BOJ will not raise rates to 1.00% until Q3 2026. This timeline is too distant to attract short-term capital inflows into the yen.

Nomura Securities highlights the key issue: for the market to interpret the rate hike as a truly hawkish signal, the BOJ needs to send stronger guidance on future rate increases—such as hinting that the next hike could occur earlier than April 2026. Otherwise, with current statements and a cautious attitude toward updating neutral rate estimates, it will be difficult for the governor to convince the market that the terminal rate for the yen will be higher.

This “rate hike paradox” reflects a reality: in a context of diverging global central bank policies, raising rates alone is insufficient to support a currency. The market needs clear policy pathways, strong language guidance, and a relative advantage compared to other economies’ policies. Currently, the Bank of Japan still has a lot of work to do in these areas.