Bank of Japan December rate hike concerns: Can the US-Japan interest rate differential drive the yen exchange rate to turn around?

The Japanese yen’s depreciation has become a thing of the past. As the Japanese government strengthens its exchange rate monitoring and expectations of the Bank of Japan raising interest rates emerge, the USD/JPY exchange rate has recently undergone a technical correction, breaking below the 156 level, with market focus reaching a peak on policy turning points.

Expectations of BOJ rate hikes intensify, but timing remains a mystery

The Bank of Japan is scheduled to announce its interest rate decision on December 19, while the Federal Reserve’s decision will be announced a week earlier. Analysts point out that the policy expectations of the two major central banks are forming a delicate balance—if the Fed maintains interest rates, it will reinforce market bets on a BOJ rate hike; conversely, if the Fed opts to cut rates, the BOJ is more likely to hold steady.

The latest market survey shows that the probability of the BOJ raising rates in December and January is roughly equal, both hovering around 50%. Carol Kong, an analyst at Commonwealth Bank of Australia, believes that the cautious BOJ may wait until the parliamentary budget bill is passed before acting, in order to buy more time to assess wage negotiations.

Narrowing US-Japan interest rate gap driving yen appreciation? Reality is more complex

Expectations of rate hikes combined with the possibility of Fed rate cuts are narrowing the US-Japan interest rate differential. Technically, this supports a retreat of the USD/JPY from high levels. However, the fundamental depreciation pressure on the yen still exists—large interest rate differentials continue to attract arbitrage flows.

UBS FX strategist Vassili Serebriakov straightforwardly states: “Relying solely on a rate hike won’t be enough to reverse the yen’s trend. Unless the BOJ adopts an aggressive hawkish stance and commits to continued rate hikes into 2026 to combat inflation, the sustainability of a currency reversal is limited.” He adds that the US-Japan interest rate gap remains significant, market volatility is still low, and these factors constrain the yen’s appreciation potential.

Government intervention threats versus market expectations: a game of chess

Jane Foley, head of FX strategy at Rabobank, presents an interesting paradox: the threat of government intervention itself is enough to curb the dollar’s rally, but this very expectation reduces the need for actual intervention. In other words, market fears of intervention may turn into a self-fulfilling prophecy, ultimately preventing real intervention from occurring.

Overall, the interplay of the BOJ’s rate hike pace, the Fed’s policy direction, and government intervention expectations is complex, making the yen’s short-term direction unclear. Investors should be cautious of volatility during rate decision periods and monitor whether changes in the US-Japan interest rate differential can sustain a currency reversal momentum.