Is the Japanese Yen appreciation facing a turning point? Central bank policy adjustments and interest rate differentials creating new opportunities

The Japanese yen’s exchange rate fell below 158 at the beginning of 2025, leading to significant divergence in market expectations for its subsequent trend. As the U.S. dollar stabilizes after strength, and the Bank of Japan accelerates policy adjustments, the possibility of yen appreciation is increasing. Industry insiders show clear differences in their year-end exchange rate forecasts, with some predicting a rise to 140 and others expecting a depreciation to 165, reflecting the complex situation and potential turning points facing the yen.

When Will the U.S. Dollar Peak, and Will the Yen Appreciate?

Last year, USD/JPY surged past 158, driven by expectations of Federal Reserve rate cuts diminishing and political uncertainties in Japan. However, over time, the dollar’s rally has lasted more than a year, and technical indicators are beginning to show signs of fatigue. Although the Fed’s rate cut expectations for early 2025 have been delayed, they haven’t disappeared entirely, leaving room for yen appreciation.

Nomura Securities’ optimistic forecast is particularly noteworthy. The firm predicts that by the end of 2026, the yen will strengthen to 140 (meaning USD/JPY drops to 140), which would be more than a 10% appreciation from 158. Nomura’s reasoning is that Trump is expected to nominate the next Fed chair as early as January 2026, and a leadership change could trigger policy adjustments. The Fed is expected to continue cutting rates intermittently until September 2026, which could reverse the dollar’s upward trend.

Diverging Central Bank Policies and the Key Role of Interest Rate Differentials

There is a clear policy divergence between Japan’s government and the Bank of Japan, which is becoming a major driver of yen appreciation. Prime Minister Sanae Sato advocates for “responsible proactive fiscal policy” to stimulate growth, but the BOJ faces a dilemma of delayed rate hikes. Data shows that although wages are improving, they still lag behind inflation. Since early 2025, real wages in Japan have declined for 11 consecutive months, putting inflationary pressure on the central bank.

Daisaku Ueno, Chief FX Strategist at Mitsubishi UFJ Morgan Stanley Securities, notes, “The central bank is stepping on the brakes while the government is stepping on the fiscal accelerator, making inflation difficult to control.” This situation forces the BOJ to accelerate rate hikes to curb rising prices. Masayuki Yoshikawa, Chief Macro Strategist at Sumitomo Mitsui DS Asset Management, believes that if concerns about delayed rate hikes diminish and prices stabilize, narrowing the interest rate differential will support yen appreciation. Specifically, a shrinking spread makes yen assets more attractive, potentially leading to a reversal of cross-border capital flows.

Market Expectations Diverge: Appreciating to 140 vs Depreciating to 165

While Nomura is optimistic about the yen reaching 140, the market remains divided. Mitsubishi UFJ Morgan Stanley Securities forecasts that by the end of 2026, the yen will weaken again to 160, and Fukuoka Financial Group predicts it could depreciate to around 165 per USD. These more pessimistic forecasts are mainly based on the continued strength of the dollar and Japan’s lagging rate hikes.

The core difference between these views lies in their expectations of the Fed’s policy shift and the pace of BOJ rate hikes. Those expecting yen appreciation believe that a start to Fed rate cuts combined with accelerated BOJ rate hikes will narrow interest differentials. Conversely, those expecting depreciation worry that, supported by global liquidity and geopolitical factors, the dollar still has room to rise, and Japan’s delayed policy response will be slow to reverse.

Real Wage Stagnation and Economic Fundamentals Challenges

Japan’s structural issues cannot be ignored. The 11-month decline in real wages indicates shrinking household purchasing power, which hampers economic growth prospects. Prime Minister Sato’s government is pushing proactive fiscal measures to offset this impact, but whether fiscal stimulus can effectively boost long-term competitiveness remains uncertain. If economic fundamentals fail to improve, even rate hikes by the central bank will have limited impact on yen appreciation.

Critical Points and Risks for Yen Appreciation

The outlook for yen appreciation depends on the synchronized development of several key factors: accelerated BOJ rate hikes, the Fed beginning rate cuts, narrowing interest rate spreads, and easing geopolitical tensions. Any deviation in these factors could alter expectations. Currently, the market remains cautious, awaiting more policy signals and economic data to confirm yen appreciation. Investors should be prepared for both the possibility of the yen rising to 140 and the risk of it depreciating to 165.