USD/JPY fluctuating at high levels, what is the probability of the Bank of Japan raising interest rates in December?

The Currency Reversal Prelude Is Playing

In recent weeks, the decline of the Japanese Yen against the US dollar has paused. In late November, high-level officials in the Japanese government sent a strong signal — Prime Minister Fumio Kishida publicly stated that they will closely monitor exchange rate movements and are prepared to intervene in the foreign exchange market if necessary. This statement immediately reversed market sentiment, with USD/JPY gradually adjusting down from a high of 156, amid a cautious market atmosphere.

Meanwhile, reports indicate that the Bank of Japan is preparing for a possible interest rate hike in December. If this expectation is confirmed, it will further push the USD/JPY bearish trend.

What Are the Key Variables for the December Decision?

Market focus is on the Bank of Japan’s interest rate decision on December 19. Analysts generally believe that the central bank’s choice will largely depend on the Fed’s stance.

If the Federal Reserve decides to hold steady and maintain current interest rates, the probability of the Bank of Japan raising rates will significantly increase. Conversely, if the Fed continues to cut rates, the likelihood of the Bank of Japan keeping rates unchanged will rise noticeably.

Current market surveys show that traders’ expectations for a rate hike by the Bank of Japan in December and January are nearly evenly split, each around 50%. Commonwealth Bank of Australia analyst Carol Kong pointed out that the conservative stance of the Bank of Japan may favor delaying a rate hike, waiting for the passage of the parliamentary budget bill, and giving time to observe the next round of wage negotiation data.

Narrowing Interest Rate Differentials Increase Exchange Rate Pressure

The rising expectation of a rate hike by the Bank of Japan and the anticipation of a rate cut by the Federal Reserve are simultaneously occurring, pushing the US-Japan interest rate differential to continue narrowing. A smaller interest rate gap means reduced attractiveness of the dollar, increasing the chance of a correction in USD/JPY from high levels.

However, it is important to remain calm, as the underlying drivers of Yen depreciation have not dissipated. Due to the still significant interest rate differential between the US and Japan, arbitrage trading (Japanese investors borrowing low-interest Yen to invest in high-yield US assets) remains strong.

UBS FX strategist Vassili Serebriakov warned that a single rate hike alone is unlikely to reverse the medium-term trend of the Yen. He emphasized that unless the Bank of Japan adopts a hawkish stance and commits to further rate hikes in 2026 to combat inflation, a one-time policy adjustment will have limited effect. Additionally, market volatility remains low, further weakening the impetus for rate hikes.

Can Intervention Deterrence Truly Change the Situation?

Jane Foley, Head of FX Strategy at Rabobank, posed an interesting paradox: if the risk of government intervention is enough to deter the dollar’s rise, it would, in turn, reduce the necessity for Japanese authorities to actually intervene. In other words, deterrence itself might be the best form of intervention.

Overall, USD/JPY is caught between multiple forces — downward pressure from expectations of government intervention and rate hikes, but upward support from interest rate differentials and arbitrage trading. The future direction depends on the Fed’s final decision at the end of the year and whether the Bank of Japan will truly have the courage to take substantial steps in December.