Does the central bank's interest rate hike lead to depreciation? The paradox in the Japanese yen exchange market and the implications for the Philippine peso exchange rate

On December 19, the Bank of Japan raised interest rates by 25 basis points to 0.75% as scheduled (a new high since 1995), but unexpectedly triggered a weakening of the yen. This contradictory phenomenon reflects the market’s deep confusion about the future direction of monetary policy.

Insufficient hawkish signals, market reaction remains lukewarm

Governor Ueda did not provide the clear forward guidance that investors were expecting during the press conference. He emphasized that future rate hikes will depend on economic and price developments but deliberately kept the schedule vague, especially avoiding any mention of the timing of the next move. More importantly, the central bank reaffirmed the neutral interest rate range at 1.0%–2.5%, not raising this key parameter as the market had anticipated.

ANZ Bank strategist Felix Ryan pointed out that although the Bank of Japan has begun a rate hike cycle, the USD/JPY exchange rate has risen to higher levels against the trend, reflecting investors’ lack of confidence in Japan’s future rate hike progress. The bank forecasts USD/JPY will reach 153 by the end of 2026 and believes the yen will still underperform among G10 currencies, with interest rate differentials remaining a disadvantage.

Diverging market expectations, Philippine exchange rate offers reference

It is worth noting that when the yen was under pressure due to insufficient hawkish signals, other emerging market currencies also faced challenges. Taking the Philippine peso as an example, regional currencies are also affected by global interest rate differentials—despite central banks gradually raising policy rates, the market still favors a strong dollar if there is no clear forward guidance. The volatility logic of the Philippine peso is similar to that of the yen: it’s not just about the interest rate figures themselves, but about how well the central bank’s policy stance matches market expectations.

State Street Global Advisors strategist Masahiko Loo maintains a medium-term USD/JPY target of 135–140, citing the Federal Reserve’s dovish stance and domestic Japanese investors increasing their risk aversion as factors sufficient to offset the yen’s support from rate hikes.

Focus on the pace of rate hikes in 2026

According to overnight index swap market pricing, investors expect the Bank of Japan to raise rates to 1.00% only in the third quarter of 2026. Nomura Securities analysts believe that only if the central bank signals an earlier rate hike (such as before April 2026) can it be interpreted as a truly hawkish stance, triggering a rebound in the yen. Otherwise, without adjusting the neutral rate forecast, even if the benchmark rate is increased, the market will find it hard to believe that the terminal rate target will be higher.

This dilemma also applies to all emerging markets relying on interest rate differentials—whether it’s the yen, the Philippine peso, or other currencies, ultimately currency strength depends on the credibility and consistency of central bank policies.