Why did the USD/JPY exchange rate decline after the Bank of Japan raised interest rates? What is the market betting on?

On December 19th, the Bank of Japan announced a 25 basis point rate hike, raising the policy interest rate from 0.5% to 0.75%, the highest level since 1995. At first glance, this is a hawkish signal and should be positive for the yen. However, the reality has gone in the opposite direction—the USD/JPY exchange rate has actually strengthened, with the dollar remaining relatively strong.

Why Is the Market “Going Against the Grain”

ANZ Bank strategist Felix Ryan pointed out that this rate hike decision might be interpreted by the market as a “dovish” move. The key is that BOJ Governor Ueda did not provide a clear commitment to the pace of future rate hikes during the press conference. He mentioned that it is difficult to pre-commit to a neutral interest rate level (currently estimated to be in the 1.0%~2.5% range), only stating that estimates will be revised when appropriate.

This ambiguous stance disappointed the market. Investors had expected to hear a more aggressive rate hike timetable, but instead received a “wait-and-see” attitude. Therefore, although the central bank has taken action, the lack of forward guidance has caused the USD/JPY to reflect doubts about the sustainability of rate hikes.

Divergence Among Institutions

Masahiko Loo, strategist at State Street Global Advisors, believes that factors such as the Federal Reserve maintaining an accommodative policy and Japanese investors increasing their foreign exchange hedging ratios will continue to support a strong dollar. He maintains a medium-term view of USD/JPY in the 135-140 range.

Meanwhile, ANZ Bank is more optimistic about the long-term strength of the dollar. The bank forecasts that by the end of 2026, USD/JPY could reach 153, citing the persistent unfavorable interest rate differential for the yen. Although they expect the BOJ to continue raising rates through 2026, the pace will not be enough to change the overall landscape.

Market “Implicit Expectations”

Overnight Index Swap (OIS) data reveal the market’s true expectations: traders generally anticipate that the BOJ will not raise rates to 1.00% until the third quarter of 2026. This timeline is quite cautious.

Nomura Securities pointed out that only if the BOJ signals that the next rate hike will come earlier—such as before April 2026—will the market see it as a genuine hawkish shift, triggering yen buying. Otherwise, without a significant upward revision of the neutral rate estimate, relying solely on the governor’s words is unlikely to convince the market that the terminal rate will see a substantial breakthrough.

Key Issue

The volatility in USD/JPY indicates a simple reality: the central bank’s rate hike decision is only superficial. The market’s real concern is the pace and endpoint of rate hikes. Governor Ueda has taken a step, but the magnitude is limited, and subsequent steps remain unclear—this is not convincing enough for investors eager for yen appreciation.