Why does the market react less than expected despite the Bank of Japan's planned interest rate hike?

After the decision on December 19th, traders fell into “disappointment.” The Bank of Japan indeed implemented a 25 basis point rate hike, raising the policy rate to 0.75%, the highest level since 1995. However, the subsequent forex market performance appeared somewhat awkward— the US dollar against the yen actually appreciated, rather than the yen strengthening as initially expected by the market.

Why does the policy signal seem insufficiently hawkish?

Governor Ueda Kazuo’s remarks at the post-meeting press conference became the focus. He did not provide a specific timetable for the next rate hike, instead emphasizing the uncertainty surrounding the estimate of the neutral interest rate. The central bank stated that the neutral rate could be in the range of 1.0% to 2.5%, a rather broad interval that left the market puzzled. The statement mentioned that if economic and price conditions meet expectations, policy adjustments would continue, but this wording was too mild, and the market generally interpreted it as lacking a clear direction.

ANZ Bank strategist Felix Ryan pointed out the essence of this contradictory phenomenon: despite the tightening policy, USD/JPY is strengthening, reflecting investors’ lack of confidence in the Bank of Japan’s future rate hike pace. The institution expects that even if the central bank continues to raise rates until 2026, the USD/JPY could reach 153 by the end of the year due to the ongoing US-Japan interest rate differential pressure on the yen.

What are the market’s real expectations?

Overnight Index Swaps (OIS) data show that traders currently expect the Bank of Japan to raise rates to 1.00% only in the third quarter of 2026. This means there is a waiting period of more than a year from now until then. Nomura Securities analysts pointed out that only when the central bank provides a more forward-looking rate hike path—such as starting the next rate hike in April 2026—will the market truly see it as hawkish, triggering yen buying.

The logic behind the exchange rate trend

Daiwa Asset Management strategist Masahiko Loo remains relatively optimistic, maintaining a medium-term target of 135-140 for USD/JPY. He believes that the support from the Federal Reserve’s easing policies, combined with Japanese institutional investors increasing their foreign exchange hedging ratios from historically low levels, collectively provide long-term support for the dollar. This means that in the short term, the US-Japan interest rate differential will continue to be a key factor in determining the exchange rate direction.

From a more macro perspective, although the Bank of Japan’s policy adjustment is symbolically significant, it appears relatively cautious within the global monetary policy landscape. This caution is the core reason for the market’s muted reaction. Investors need not only rate hikes themselves but also clear policy paths and more hawkish forward guidance. Before these are actively priced into the market, the yen’s appreciation potential may be limited.