Does the central bank's rate hike lead to depreciation? The yen-dollar divergence puzzle

On December 19th, the Bank of Japan announced a 25 basis point rate hike, raising the policy interest rate to 0.75%—the highest level since 1995. However, to the market’s surprise, after the rate hike announcement, the yen did not appreciate against the US dollar; instead, it continued to weaken, with the dollar remaining strong.

Lack of Hawkish Signals, Market in Trouble

Bank of Japan Governor Haruhiko Kuroda stated at a press conference that if economic and inflation prospects meet expectations, the central bank will continue to raise rates. But the issue is that he did not provide a clear timetable for future rate hikes. Governor Kuroda emphasized that accurately judging the neutral interest rate level is difficult and plans to revise the current neutral rate estimate range (1.0%–2.5%) in a timely manner.

This ambiguous stance immediately triggered market reactions. ANZ Bank strategist Felix Ryan believes that although the central bank has initiated policy adjustments, the yen against the dollar remains under pressure—while the dollar continues to appreciate. The fundamental reason is that the market has not received clear guidance on the pace and magnitude of future rate hikes.

The Spread Still Matters, Is 2026 a Turning Point?

ANZ Bank forecasts that although the Bank of Japan may continue to raise rates in 2026, the yen will still be at a disadvantage in the G10 group of currencies, as the interest rate differential remains unfavorable for the yen. The institution’s target price suggests that by the end of 2026, USD/JPY could rise to 153.

Fidelity Investment Management strategist Masahiko Loo pointed out that the dual factors of the Federal Reserve’s easing policy and Japanese investors increasing their foreign exchange hedging ratios are still supporting the dollar’s strength. He maintains a long-term target of 135–140 for USD/JPY.

When Will the Market Turn?

Overnight Index Swap (OIS) data shows that traders generally expect the Bank of Japan to raise rates to 1.00% by Q3 2026. Nomura Securities noted that only when the central bank signals a faster rate hike than this timetable (for example, an early move to April 2026) will the market react hawkishly and push the yen higher against the dollar.

Without a significant revision to the neutral rate estimate, it will be difficult for the central bank governor to convince the market that the terminal rate will rise substantially, thereby reversing the current yen depreciation trend.