Japanese exchange rate fluctuates wildly! Despite the central bank raising interest rates, it failed to support the yen. What will happen to Japan in 2026?

On December 19th, the Bank of Japan (BOJ) raised interest rates by 25 basis points as scheduled, bringing the benchmark rate to 0.75%, the highest level since 1995. However, surprisingly, this hawkish move did not strengthen the yen; instead, the USD/JPY exchange rate rose in response, and market reactions were unexpected.

Ambiguous signals from the central bank, market disappointed

Governor Ueda Haruhiko took a relatively cautious stance at the subsequent press conference. Although the central bank’s statement indicated that if economic and price outlooks meet expectations, further rate hikes would continue, the governor did not provide a clear timeline for the specific rate hike schedule that the market was expecting. Particularly regarding the definition of the neutral interest rate level (currently estimated to be in the range of 1.0% to 2.5%), he stated that it is difficult to determine in advance and plans to adjust when appropriate.

This ambiguous stance led to differing interpretations among market participants regarding the central bank’s future policy direction. Strategist Masahiko Loo of State Street Global Advisors directly stated that investors interpreted this rate hike decision as a dovish signal, resulting in short-term sharp fluctuations in the yen.

Multiple institutions analyze: interest rate differentials suppress yen appreciation

Felicity Ryan, a strategist at ANZ Bank, pointed out that despite the BOJ officially entering a rate hike cycle, the USD/JPY exchange rate rose instead, reflecting the market’s lack of clear understanding of the pace and magnitude of future BOJ rate hikes. The bank believes that although the BOJ is expected to continue raising rates into 2026, the international interest rate differentials remain unfavorable for the yen, and the yen’s performance among G10 currencies is expected to remain under pressure. According to ANZ Bank’s forecast, the USD/JPY exchange rate could reach 153 by the end of 2026.

State Street Global Advisors maintained its long-term target for USD/JPY, expecting the rate to trade within the 135-140 range. The firm’s analysis suggests that the continuation of easing policies by the Federal Reserve, combined with Japanese investors increasing their foreign exchange hedging ratios from historically low levels, supports the sustained strength of the USD against the yen.

Disparity between market expectations and central bank guidance

According to overnight index swap (OIS) market data, traders generally expect the BOJ to raise rates to 1.00% around the third quarter of 2026. However, Nomura Securities’ analysis team believes this expectation may be overly optimistic. They point out that only if the BOJ’s guidance clearly indicates that the next rate hike will come earlier (for example, as early as April 2026 or sooner) will the market truly interpret it as a hawkish signal, prompting yen buying.

Under current circumstances, unless the BOJ significantly raises its neutral rate estimate, it will be difficult for the governor to convince the market that the terminal rate will substantially increase. This lack of clear guidance is a key factor suppressing yen appreciation.

Outlook: multiple uncertainties in Japan’s exchange rate trend

The core issue facing the market is whether the BOJ’s rate hike policy is sufficient to change the long-term depreciation trend of the yen. Based on this December decision, the magnitude and pace of the central bank’s policy adjustments have not fully met market expectations. The future direction of the Japanese exchange rate depends not only on the BOJ’s policy stance but also on global interest rate differentials, investor risk appetite, and the Federal Reserve’s policy trajectory.