Bank of Japan's December decision imminent: In the context of soft US CPI, the rate hike magnitude becomes crucial

The Bank of Japan Governor Kazuo Ueda is scheduled to announce the latest interest rate decision on December 19. The market widely expects a 25 bps hike to 0.75%, reaching a thirty-year high. While this move is not surprising, amid the continued moderation of US CPI data, market traders’ focus has quietly shifted: Is the central bank more inclined towards an “aggressive” or “cautious” policy stance in the future?

Fully Priced-In Rate Hike Expectations Signal Market Focus

When the rate hike decision itself is no longer a surprise, investors begin to focus on Ueda’s reassessment of the neutral rate and natural rate. Most institutions believe that the Bank of Japan may revise its estimates of the neutral rate, raising the lower bound from the current 1.0%, which will directly impact expectations for the terminal rate. According to market pricing, investors expect interest rates to reach 1.0% by September 2026.

Nomura Securities remains cautious, believing that current market expectations may be overly optimistic, and the magnitude of the rate hike could be overestimated.

Arbitrage Trading Reversal Risks Still Exist

The biggest concern with Japan’s rate hike is the potential for large-scale unwinding of USD/JPY arbitrage trades. If this occurs, a large amount of capital will flow back from US stocks, cryptocurrencies, and other high-risk assets into Japan, triggering market volatility. The scene from July last year is still fresh—when the BOJ unexpectedly raised rates to 0.25%, the yen surged, followed by declines in US stocks and Bitcoin.

However, this time the impact may be relatively mild. On one hand, rate hike expectations have been fully priced in; on the other hand, ongoing domestic fiscal stimulus policies in Japan continue to suppress the yen, partially offsetting the appreciation effects of rate hikes.

“Dovish” vs “Hawkish”: Two Possible Scenarios for USD/JPY

U.S. banks indicate that if the BOJ adopts a “dovish rate hike” stance, USD/JPY will remain relatively high, potentially surging toward 160 early next year. If the central bank demonstrates a “hawkish rate hike” posture, it could trigger a short covering rally in yen shorts, pushing USD/JPY toward the 150 level. However, analysts believe the latter scenario is less likely.

U.S. banks’ quarterly target prices for USD/JPY in 2026 are: 160 in Q1, 158 in Q2, 156 in Q3, and 155 in Q4.

In contrast, Nomura Securities is relatively optimistic. The firm points out that the continued depreciation of the yen is increasing political pressure within Japan, and the narrowing US-Japan interest rate differential will weaken the attractiveness of yen arbitrage trades. Nomura forecasts target prices for the four quarters of 2026 as 155, 150, 145, and 140, respectively, indicating a gradual yen appreciation.

The moderation of US CPI data is supporting global liquidity, but every step of the BOJ’s rate hike could rewrite this landscape.