Is the Yen appreciation window still illusory? The US-Japan interest rate differential determines Japan's depreciation endgame

The central bank’s policy dilemma leaves the yen exchange rate stuck in a stalemate.

Recently, the yen has become a market focus, but its trend is full of contradictions. The USD/JPY has fallen from high levels to below 156, seemingly a clear sign of appreciation, but hidden dangers lurk beneath. The core contradiction behind this is: rising expectations of the Bank of Japan raising interest rates coexist with the fundamental pressure for yen depreciation.

Rate hike expectations emerge, but do not necessarily mean yen appreciation

At the end of November, the Japanese government sent a strong signal. Prime Minister Fumio Kishida announced that the government would closely monitor exchange rate fluctuations and be prepared to take necessary action in the foreign exchange market at any time. Subsequently, market rumors suggested that the Bank of Japan might initiate a rate hike in December.

Once these voices appeared, the USD/JPY responded with a decline. By November 27, the exchange rate briefly fell below 156, leading investors to believe that the era of yen appreciation might be coming. But analysts raised new questions: will a rate hike truly change Japan’s depreciation situation?

December’s decision timing is crucial. The Bank of Japan’s monetary policy meeting is scheduled for December 19, with the Federal Reserve announcing its decision the week before. Market forecasts suggest both possibilities: the Bank of Japan has about a 50% chance of raising rates in December or January.

Carol Kong, an analyst at Commonwealth Bank of Australia, believes that the cautious Bank of Japan might wait until the parliament passes the budget bill before raising rates. This approach can both gain leverage and observe the progress of the next wage negotiations. This “wait and see” strategy actually reflects the central bank’s cautious attitude toward the timing of rate hikes.

The real root of yen depreciation is the interest rate differential

The seemingly optimistic rate hike expectations cannot hide a harsh reality: the interest rate gap between Japan and the US remains large.

Even if the Bank of Japan raises rates, arbitrage trading continues. Investors borrow low-interest yen and invest in high-interest dollar assets. This trading logic is difficult to completely reverse in the short term. Vassili Serebriakov, FX strategist at UBS, bluntly states: “A single rate hike is far from enough to change Japan’s depreciation trend. Unless the Bank of Japan takes aggressive measures and commits to continuous rate hikes through 2026 to control inflation, the effect will be limited.”

Jane Foley, head of FX strategy at Rabobank, also pointed out the market’s subtle psychology: “If concerns about government intervention become strong enough, they may actually reduce the likelihood of actual intervention.” In other words, the mere expectation of intervention can weaken market enthusiasm and suppress appreciation potential.

Will the yen appreciate or depreciate? The key points are these

The current situation presents a triangular deadlock. Expectations of a rate hike by the Bank of Japan support the yen’s short-term performance, but the wide US-Japan interest rate differential and arbitrage logic still exist. The Fed’s next move becomes a decisive factor.

If the Fed maintains interest rates in December, it will significantly increase pressure on the Bank of Japan to raise rates. But if the Fed chooses to cut rates, the Bank of Japan is more likely to hold steady, reinforcing Japan’s depreciation trend. This means that the marginal change in US monetary policy could directly determine the Bank of Japan’s choice.

The market is currently in a wait-and-see mode. The fundamental pressure for yen depreciation has not disappeared, but rate hike expectations provide short-term support. Whether this window can translate into actual appreciation depends on whether the central bank’s policy decisions are sufficiently firm and whether the US-Japan interest rate gap can accelerate narrowing.