Why did the yen fall after the Bank of Japan raised interest rates? Why is the market not convinced by the 0.75%?

The Bank of Japan announced a 25 basis point rate hike on December 19, pushing the policy interest rate to 0.75%, the highest in nearly 30 years. On the surface, this appears to be a firm hawkish move, but the market’s reaction was unexpected—the USD/JPY exchange rate not only did not fall but continued to rise, putting the yen in an awkward situation of “rate hike leading to depreciation.”

Ambiguous Policy Signals, Market Senses “Dovish” Tone

The key issue is that Governor Ueda Haruhiko did not provide a clear timeline for subsequent rate hikes during the press conference. He admitted that it is difficult to lock in a neutral interest rate (estimated range 1.0%-2.5%) in advance and plans to revise estimates based on circumstances. This wording caused confusion in the market—if even the neutral rate is uncertain, how can future rate hike guidance be provided?

ANZ Bank strategist Felix Ryan pointed out that although the Bank of Japan has already started raising rates, the market remains “confused” about the pace and magnitude of its hikes. This uncertainty has caused the USD/JPY to rise, as investors cannot be sure that the BOJ will continue to push for normalization decisively and consistently.

The Interest Rate Differential Still a “Roadblock”

Even if the BOJ continues to raise rates in 2026 (market consensus expects rates to reach 1.00% by Q3), the relatively accommodative stance of the Federal Reserve means that the interest rate differential between the US and Japan remains unfavorable for the yen. It’s like two cars racing—although the Japanese car accelerates, the American car is still faster, so the Japanese car cannot catch up for now.

DFA Investment Management strategist Masahiko Loo maintains a medium-term target of 135-140 for USD/JPY, citing the Fed’s policy support for dollar demand and the increasing foreign exchange hedging ratio among Japanese investors from historically low levels, which also boosts dollar demand.

What Counts as a “Hawkish” Signal?

Market appetite is actually quite large. Nomura Securities analysts believe that only when the BOJ provides clear forward guidance such as “the next rate hike may occur earlier than April 2026” will it be seen as a true hawkish signal. Such signals can truly stimulate yen buying.

In other words, the rate hike itself is no longer news—what matters is telling the market “we will persistently continue to raise rates.” Against the backdrop of not significantly revising the neutral rate estimate upward, such a commitment is particularly difficult.

Outlook for 2026: USD/JPY May Continue to Stay High

Based on forecasts from various institutions, USD/JPY is expected to remain under pressure in 2026. ANZ Bank predicts it could rise to 153 by year-end, reflecting that even if the BOJ continues to hike rates, the global interest rate differential is unlikely to reverse in the short term. The overnight index swap market also reflects similar expectations—investors generally believe the BOJ’s rate hike pace will be relatively moderate and spaced out.

The core contradiction in the current market is that the BOJ has begun normalizing, but its pace is not fast enough, not steady enough, and its guidance is not clear enough. This precisely is the “lukewarm” attitude that investors least want to see.