The yen's sharp decline intensifies the Bank of Japan's policy contradictions [Forex Weekly Report]

Weekly Market Overview

Last week (12/15-12/19), the US Dollar Index rose by 0.33%, while non-USD currencies showed mixed performance. The euro declined by 0.23%, the yen fell the most by 1.28%, the Australian dollar dropped by 0.65%, and the British pound slightly increased by 0.03%. The core driver of the forex market this week stems from divergence in central bank policies and market expectation mismatches.

Conflict Between Rate Hikes and Fiscal Stimulus: Why Is the Yen Continually Depreciating?

USD/JPY increased by 1.28% last week, seemingly indicating dollar strength, but in reality reflecting contradictions in the Bank of Japan’s policy.

The Bank of Japan raised interest rates by 25 basis points as scheduled, which should support the yen. However, Governor Ueda Kazuo’s dovish tone caused the market to lose expectations of further rate hikes. More critically, Prime Minister Sanae Suga announced a fiscal stimulus plan totaling up to 18.3 trillion yen, a large-scale expenditure that directly dilutes the tightening effect of the rate hike.

The result is: the rate hike signal is offset by fiscal expansion, and the yen loses policy support. The market now expects the Bank of Japan to cut rates only once by 2026, with Sumitomo Mitsui Banking Corporation even predicting the next rate hike will not occur until October 2026. This indicates long-term pressure for yen depreciation remains.

Yen Approaching 158, Government Intervention Becomes a Suspense

USD/JPY is nearing the psychological threshold of 158. The significance of this level lies not in technical terms but in policy bottom lines.

JPMorgan warns that if the yen depreciates against the dollar beyond 160 in the short term, it will be defined as a sharp exchange rate movement, increasing the likelihood of direct intervention by the Japanese government. In other words, 158-160 is the limit tolerable by Japanese authorities.

However, market outlooks are divided: Sumitomo Mitsui Banking predicts the yen will depreciate to 162 (quite bearish), while Nomura Securities holds the opposite view, believing that under the Fed’s rate cuts, the dollar will not continue to strengthen, and forecasts USD/JPY to appreciate to 155 in Q1 2026. These institutional disagreements reflect the current uncertainty in the situation.

Euro Bullish Sentiment Rises, but US Data Remains a Variable

EUR/USD fell by 0.23% last week, but from institutional perspectives, bearish sentiment has not dominated.

The ECB maintained interest rates unchanged, and President Lagarde did not give hawkish signals expected by the market. On the US side, November non-farm payroll data was mixed, and CPI was below expectations. Importantly, major banks like Morgan Stanley and Barclays warn that these data are subject to significant technical distortions and statistical biases, making them unreliable indicators of true economic trends.

Market pricing shows the Fed is expected to cut rates twice by 2026, with a 66.5% probability of a rate cut in April. Danske Bank’s view is representative: since the Fed is expected to cut rates while the ECB holds steady, the narrowing interest rate differential favors the euro. Additionally, the revival of European assets, increased hedging against US dollar depreciation risks, and declining confidence in US institutions could further boost the euro.

Technical Outlook and This Week’s Prospects

EUR/USD: Remains above multiple moving averages, with potential for a short-term rally. Key resistance is near the previous high around 1.18. If it pulls back, support is around the 100-day moving average at approximately 1.165. This week, US Q3 GDP data will be decisive—better-than-expected data will favor the dollar and pressure EUR/USD, while weaker data will support the euro.

USD/JPY: Has broken above the 21-day moving average, with MACD showing a buy signal. A break above 158 resistance could open up further upside. However, this also triggers potential policy intervention. Focus this week on speeches by BOJ Governor Ueda Kazuo and any verbal interventions by Japanese authorities. If Ueda’s comments turn hawkish or intervention escalates, USD/JPY could decline, with support around 154.

Overall, the key themes in the forex market this week are “policy divergence” and “data noise.” Investors should closely monitor central bank communications and economic data, while remaining alert to sudden policy interventions.