The Japanese Yen faces ongoing pressure! Why does the market turn bearish after the central bank raises interest rates?

The Bank of Japan announced a 25 basis point rate hike on December 19, raising the policy interest rate to 0.75%, the highest level since 1995. However, the market’s reaction was unexpected—the USD/JPY exchange rate did not decline as a result; instead, it showed an upward trend. What signals are hidden behind this?

Lack of Clear Forward Guidance in the Rate Hike Decision

The statement by BOJ Governor Kazuo Ueda at the press conference became the key. Although the statement emphasized that if economic and price outlooks meet expectations, further rate hikes would continue, Governor Ueda did not provide clear guidance on the timing of the next rate increase. He mentioned that determining the neutral interest rate level is difficult, and the central bank plans to adjust its estimate of the neutral rate range (currently 1.0%~2.5%) as appropriate.

This ambiguous stance led to differing interpretations in the market. Strategist Masahiko Loo of State Street Global Advisors pointed out that investors might view this rate hike as dovish, putting short-term pressure on the yen. The firm maintains a long-term target of 135-140 for USD/JPY, believing that the accommodative environment of the Federal Reserve and Japanese investors increasing their foreign exchange hedging ratios still support the yen.

Market Expectations and Central Bank Guidance Are Mismatched

ANZ Bank strategist Felix Ryan analyzed that the rise in USD/JPY reflects traders’ lack of confidence in the Bank of Japan’s future pace and magnitude of rate hikes. Although the market generally expects the BOJ to continue its rate hike cycle into 2026, the interest rate differential environment is not favorable for the yen. The bank forecasts USD/JPY to rise to 153 by the end of 2026.

Data from the overnight index swap market shows traders expect the BOJ to raise rates to 1.00% at the earliest in Q3 2026. Nomura Securities believes that only when the BOJ signals that the next rate hike could come earlier (for example, before April 2026) will the market truly react hawkishly and stimulate yen buying.

Yen Underperforms Among G10 Crosses

The current reality is that the yen is relatively weak against the G10 currency basket. This mainly stems from two factors: first, the Japan-US interest rate differential remains high, which is unfavorable for yen appreciation; second, Japanese investors are gradually increasing their hedging positions in USD, EUR, and others, which also suppresses yen upside momentum.

Unless the BOJ Governor can provide sufficiently convincing guidance—indicating that the terminal rate will exceed market expectations—it will be difficult to persuade the market that there is a solid basis for significant yen appreciation solely by not substantially adjusting the neutral rate estimate.

The market is currently awaiting further statements from the BOJ in 2026. Whether the next rate hike will occur as expected in the third quarter will be a key factor in determining the future direction of the yen.