Why does the yen continue to depreciate after the Bank of Japan raises interest rates? Is there still room for rate hikes in 2026?

December 19, Japan’s central bank as scheduled raised the benchmark interest rate by 25 basis points to 0.75%, reaching a nearly 30-year high. However, the market reaction was unexpected—the USD/JPY exchange rate actually appreciated. What exactly happened behind this?

Signal of rate hike not “hawkish” enough, yen drops accordingly

The Governor of the Bank of Japan, Kazuo Ueda, became the key figure in the press conference. Although the statement emphasized that if economic and price outlooks proceed as expected, interest rates will continue to rise, Ueda did not clearly specify the timeline for the next rate hike. He admitted that it is difficult to determine the neutral interest rate level in advance and plans to revise the neutral rate estimate range (currently 1.0%~2.5%) when conditions permit.

ANZ Bank strategist Felix Ryan pointed out that the market interprets this move as “dovish” because of the lack of clear guidance on the path of future rate hikes. This ambiguous stance actually dampened yen buying. According to overnight index swap (OIS) data, the market expects the Bank of Japan to raise rates to 1.00% only by Q3 2026, which is well below the previous hawkish expectations.

Interest rate differential dilemma: Will the yen still rise?

Even though the Bank of Japan has started a rate hike cycle, the trend of USD appreciation has not reversed. The interest rate differential remains a decisive factor—the Federal Reserve’s easing policy contrasts sharply with the BOJ’s cautious stance, causing the yen to continue weakening against G10 currencies.

ANZ Bank forecasts that by the end of 2026, the USD/JPY exchange rate will reach 153. Strategist Masahiko Loo of Dreyfus Investment Management maintains a longer-term target of 135-140 for USD/JPY, believing that the Fed’s accommodative policy and Japanese investors increasing their foreign exchange hedging ratios will continue to support the dollar.

Is a rate hike in 2026 possible?

Nomura Securities’ analysis indicates that only when the BOJ provides a more hawkish forward guidance—such as hinting that the next rate hike could occur earlier than April 2026—will the market significantly buy into the yen. Otherwise, without substantially revising the neutral interest rate estimate higher, it will be difficult for the central bank governor to convince investors that the ultimate rate will go higher.

In other words, the BOJ may indeed continue to raise rates in 2026, but the key is not the rate hikes themselves, rather whether the BOJ can provide sufficiently strong policy commitments. Until then, the upward momentum of the yen is likely to be limited.