Conventional logic suggests that when a central bank raises interest rates, its domestic currency tends to appreciate. This principle, however, clearly does not apply to Japan's current situation: in 2025, the Bank of Japan implemented two rate hikes, totaling 50 basis points. Among major developed economies globally, the BoJ stands alone in tightening monetary policy. Theoretically, the yen should be outperforming its peers, with its value climbing steadily.
Throughout 2025, the USD/JPY pair rose continuously from a low of 139.88 to a high of 158.87, representing a depreciation of 13.57% for the yen, which exceeded the declines seen in most other major non-US currencies. The actual market performance has severely deviated from logical analysis; instead of appreciating during the central bank's hiking cycle, the yen has shocked the market with a pronounced depreciatory trend.
Such an illogical price movement indicates that a more powerful factor is dominating the yen's valuation.
Even after several rate hikes, Japan's current benchmark interest rate is only 0.75%, which remains significantly lower than the United States' 3.75%, China's 3%, and Germany's 2.15%. This means that the yen, even post-hike, has not escaped its fate as a "funding currency": financial institutions borrow yen at low cost, convert it into US dollars, and invest in higher-yielding currencies and assets.
In other words, during the Bank of Japan's rate-hike period, domestic capital within Japan has been flowing out of the country through various channels, ultimately leading to the depreciation of the yen's value.
This situation has a potential tipping point: when the Bank of Japan raises rates to a certain level—for instance, bringing them in line with the average interest rates of Western nations—the cost of borrowing yen increases sharply, prompting international capital to begin flowing into Japan. A substantial influx of returning funds would likely lead to high inflation in Japan and, simultaneously, significantly boost the value of the yen.
The mainstream view holds that in 2026, the Bank of Japan will implement two more rate hikes of 25 basis points each. Based on this projection, Japan's benchmark interest rate would reach 1.25% by year-end. Considering that the US Federal Reserve is expected to cut rates approximately three times in 2026, totaling 75 basis points, the US benchmark rate could fall to 3%. The interest rate differential between Japan and the US would narrow significantly, potentially leading to a stronger-than-expected appreciation of the yen.
It is important to note that a prevailing view in the market is that the Bank of Japan's rate hikes are a short-to-medium-term measure, as Japan's inflation remains unstable, and further tightening could risk triggering a more substantial recession for the country. This perception is also a key factor contributing to the current lack of confidence in the BoJ's hiking cycle and the persistent weakness of the yen.
Regarding the market outlook, on an hourly chart, USD/JPY is in a short-term corrective phase. During today's session (as of the early European session), the pair touched a low of 157.95, showing signs of finding support with a relatively long lower shadow. However, the current price still has some distance to the lower boundary of the channel, leaving room for further declines. Given that the previous rebound wave reached inside the 158.6-158.9 Fibonacci retracement zone, the probability of the current downtrend extending to test the channel's lower support appears higher than the likelihood of an immediate supportive bounce.
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