Does the Japanese Yen depreciate after interest rate hikes? Why isn't the market convinced?

On December 19th, the Bank of Japan announced a rate hike decision, raising the interest rate from 0.5% to 0.75%, marking the highest level in nearly thirty years. However, unexpectedly, the USD/JPY exchange rate rose immediately after the rate hike, reflecting investors’ concerns about the future policy trajectory.

The “Ambiguous Signal” from the Central Bank

Governor Ueda did not provide a clear timetable for the rate hike during the press conference, only stating that adjustments would be made flexibly based on economic and inflation outlooks. The central bank also revised its neutral interest rate estimate range to 1.0%~2.5%, but did not make any explicit commitments on when this level would be reached. This cautious language is generally interpreted by the market as a “soft landing” inclination rather than the firm stance investors had hoped for.

Nomura Securities analysts believe that only when the central bank signals a rate hike before April 2026 will it be enough to trigger yen buying. In the absence of such clear prospects, even with the rate already increased, the yen remains under downward pressure.

Interest Rate Differentials as a Decisive Factor

ANZ Bank strategist Felix Ryan pointed out that there is still a significant interest rate differential between the US and Japan, which favors USD appreciation. The bank forecasts that by the end of 2026, USD/JPY will rise to 153, as even if the Bank of Japan continues its rate hike cycle, the yen will remain relatively weak under the global easing policy expectations.

State Street Global Advisors maintains a medium-term target of 135-140 for USD/JPY. The firm’s analysis suggests that the Federal Reserve’s continued easing stance, combined with increased foreign exchange hedging demand from Japanese institutional investors, jointly support the strength of the dollar.

The Pace of Rate Hikes in 2026 Needs Clarification

Overnight index swap markets reflect investor expectations that the Bank of Japan will raise interest rates to 1.00% in Q3 2026, which is over a year away. This relatively moderate timeline makes it difficult to immediately change the market’s pessimistic view of the yen.

In the short term, the initial yen rally following the rate hike announcement has faded, and the exchange rate has reversed downward, reflecting ongoing market doubts about the central bank’s policy resolve. To reverse this trend in the future, the Bank of Japan needs to provide a more aggressive rate hike roadmap in the next meeting or related statements to rekindle international capital interest in yen allocation.