Federal Reserve decision influences the outlook of the Japanese Yen: The dilemma at the crossroads of central bank interest rate hikes

The Bank of Japan’s interest rate hike decision at the December policy meeting is directly influenced by the Federal Reserve (Fed) in the United States. This cross-border policy coordination has become a key variable affecting the yen’s movement.

Policy Expectations and Exchange Rate Balance

As of late November, the depreciation trend of the yen against the US dollar has shown signs of easing. USD/JPY has retreated from the high of around 156, and the market generally attributes this adjustment to rising expectations of rate hikes. Japanese Prime Minister Sanae Takashi explicitly stated that the government will closely monitor exchange rate movements and is prepared to intervene in the foreign exchange market at any time.

Following this policy signal, market expectations that the Bank of Japan may act in advance have increased. Sources indicate that the Bank of Japan is considering raising interest rates at the December 19 rate decision. Meanwhile, the Fed’s rate decision will be announced a week before the BOJ meeting, creating a timing gap that adds uncertainty to the latter’s decision-making environment.

Interest Rate Differential and Arbitrage Pressure

Although expectations for rate hikes have increased, the fundamental driver of yen depreciation—the US-Japan interest rate differential—remains. The interest rate gap between the US and Japan is still high, continuously incentivizing large-scale arbitrage trading (borrowing low-interest yen to invest in high-yield US dollar assets).

UBS FX strategist Vassili Serebriakov emphasized that a single rate hike may not be enough to fundamentally reverse the exchange rate pattern. Only if the BOJ adopts a hawkish stance and commits to continuing its tightening cycle into 2026 to combat inflation could market expectations be significantly altered.

Fed Rate Cuts vs. BOJ Rate Hikes: Policy Paradox

Current market forecasts suggest about a 50% probability of the BOJ raising rates in December and January each. Analysts note that this balance reflects cautious policymaker attitudes.

Australian Commonwealth Bank analyst Carol Kong believes that the BOJ may prefer to wait until the parliament approves the budget before acting, which allows time to observe wage negotiations and alleviates concerns about aggressive rate hikes. Meanwhile, if the Fed maintains its interest rate level, it will significantly increase pressure on the BOJ to hike; conversely, if the Fed starts cutting rates, it will reduce the urgency for the BOJ to act immediately.

Uncertainty of Exchange Rate Reversal

Jane Foley, Head of FX Strategy at Rabobank, pointed out that expectations of intervention themselves have the ability to suppress the dollar’s rally, which may reduce the likelihood of actual intervention—an example of a self-fulfilling policy signaling.

The combined effect of narrowing US-Japan interest rate differentials and rate hike expectations increases the possibility of USD/JPY retreating from recent highs. However, to fully reverse the depreciation trend, the BOJ needs to adopt more decisive and sustained policy signals. Currently, the market is in a wait-and-see phase, awaiting the two major central bank decisions in mid-December.