The yen's sharp decline draws attention! Why is the market's reaction to the Bank of Japan's rate hike so lukewarm?

The Bank of Japan announced a 25 basis point rate hike on December 19, raising the interest rate from 0.5% to 0.75%, the highest level since 1995. However, the market reaction was not as enthusiastic as expected—the USD/JPY exchange rate actually appreciated, indicating that investors still have doubts about the future policy direction.

Central Bank Stance Not Hawkish Enough, Market Faces Dilemma

The core issue lies in Governor Ueda’s overly cautious attitude. Although the BOJ stated in its statement that it would continue to raise rates if economic and inflation prospects meet expectations, Ueda avoided making specific commitments on the timing of future rate hikes during the press conference. He admitted that it is difficult to determine the neutral interest rate in advance and only plans to adjust the existing estimate of the 1.0%–2.5% range if necessary.

ANZ Bank strategist Felix Ryan pointed out that despite the start of the rate hike cycle, the yen has not strengthened accordingly. “The market lacks clear guidance on the pace and magnitude of future rate increases, limiting support for the yen.” He further predicted that even if the BOJ continues to raise rates in 2026, the interest rate differential environment will remain unfavorable for the yen, with USD/JPY expected to be around 153 by the end of the year.

Divergent Institutional Views, Timing of Rate Hikes Is Key

The current overnight index swap (OIS) market shows that traders expect the BOJ to raise rates to 1.00% only by Q3 2026. This expectation reflects a cautious market attitude—such a prolonged rate hike cycle makes it difficult to provide strong support for the yen.

Fidelity Investment Management strategist Masahiko Loo believes that the Fed maintaining an accommodative policy, combined with Japanese investors increasing their foreign exchange hedging ratios, is enough to keep USD/JPY stable in the 135–140 range. In other words, unless the BOJ signals an earlier rate hike—such as in April 2026—the yen is unlikely to appreciate significantly.

Nomura Securities bluntly stated: only when the BOJ hints that the next rate hike could come earlier than scheduled (e.g., in April 2026) will the market interpret this as a hawkish stance, triggering a wave of yen buying. Given the current modest adjustments to the neutral rate estimate, it is difficult for the central bank governor to convince the market that the terminal rate will rise to higher levels.

Investors’ True Thoughts

The market’s tepid response to rate hikes essentially reflects a reality: the magnitude and pace of rate increases are more important than the policy itself. The pressure on the yen to depreciate remains heavy, and the relative attractiveness of the dollar has not diminished. To truly turn the situation around, the BOJ may need to adopt a more hawkish stance—both acting proactively on the timing of rate hikes and providing market confidence regarding the terminal rate target.