Bank of Japan December Decision Preview: 0.75% Rate Hike Has Become Certain, Key Will Be How Subsequent Signals Evolve

Bank of Japan Governor Kazuo Ueda is set to reveal the decision on December 19—markets are almost certain to see a 25 basis point rate hike, raising the target rate to 0.75%. But the real focus isn’t on the rate hike itself, but on the central bank’s stance on future policy directions.

Is the reverse unwind of carry trades really coming?

Carry trades seem simple: borrow low-interest yen, invest in high-yield assets (US stocks, emerging market bonds, cryptocurrencies), and earn the interest spread. Japan’s lowest interest rates in 30 years have provided the most lucrative arbitrage opportunity in three decades. But once Japan raises rates, how intense will the chain reaction of unwinding carry trades be?

The market’s painful lessons have answered this question. In July 2024, Japan’s surprise rate hike to 0.25% triggered a mini-tsunami—the yen surged, US stocks plunged, and Bitcoin dropped accordingly. Although a 0.75% hike was already priced in, the risk of a reversal in liquidity conditions still exists.

However, analysts generally believe this shock will be much milder. There are two reasons: first, the market has already fully priced in the rate hike expectations, with no black swan; second, the Japanese government’s large-scale fiscal support continues to inject liquidity into the economy, offsetting some of the yen’s appreciation pressure.

Central bank stance will determine next year’s exchange rate direction

This is the core issue—will Ueda adopt a hawkish or dovish tone?

Nomura Securities holds a relatively conservative view. They believe the market’s expectations for the pace of rate hikes may be overly optimistic, and the BOJ will be cautious when adjusting its neutral rate estimates. They project USD/JPY at: 155 in Q1, 150 in Q2, 145 in Q3, and 140 in Q4. In other words, Nomura is optimistic about yen appreciation.

Bank of America’s stance is more flexible. If the BOJ signals a dovish shift (implying a slowdown in rate hikes), USD/JPY could hover at high levels and possibly spike to 160 early next year. But if hawkish signals emerge (rapid rate increases), short covering of yen shorts could push the exchange rate down toward 150. Bank of America’s forecast for the full year is a decreasing path: 160 → 158 → 156 → 155.

Looking at the global currency landscape through the yen

Every move by the BOJ will ripple across the entire Asian currency landscape. The Philippine peso, Thai baht, Korean won, and other emerging market currencies could all be affected by yen appreciation or depreciation. When the yen surges rapidly, the risk of capital outflows from emerging markets increases—carry traders will not only unwind yen positions but also withdraw from other high-risk emerging assets. This could put downward pressure on currencies like the Philippine peso against the RMB.

How much room is there for terminal rates?

The market currently prices in a scenario where Japan’s rates will rise to 1.0% by September 2026. It doesn’t sound like much, but that implies the BOJ needs to hike an additional 25 basis points within two years. An underlying question is: what is the neutral interest rate? Will the BOJ raise its estimate of the neutral rate? If the neutral rate is adjusted upward from the current 1.0%, it means more rate hikes are possible—this is where Nomura and Bank of America diverge.

The BOJ’s decision may just be the prelude. The real drama will unfold at the governor’s press conference.