The end of 2025 brought a phenomenon to financial markets which some investors could call a “paradox”. At its center was Japan, attempting to finally break away from the legacy of decades of monetary stagnation, and the yen, which behaved in a way that ran counter to textbook economic intuition. Despite an interest rate hike, the Japanese currency failed to strengthen and instead remained weak against the world’s major currencies.
The end of the ultra-low rate era – or not quite?
For decades, Japan operated under an ultra-loose monetary policy aimed at combating deflation. December 2025 was meant to mark a turning point. Inflation in the Land of the Rising Sun had remained above the Bank of Japan’s 2% target for 44 consecutive months, reaching 2.9% year over year in November. Even so, following the December decision, monetary policy remained firmly in stimulative territory. The Bank of Japan emphasized in its statement that real interest rates would remain significantly negative and that financial conditions would continue to support economic growth.
It is precisely these negative real interest rates that provide the key to understanding the yen’s persistent weakness. With inflation at 2.9% and the nominal policy rate at 0.75%, Japan’s real cost of money stands at approximately –2.15%. This implies an ongoing erosion of purchasing power for yen-denominated cash holdings, structurally discouraging investors from accumulating the Japanese currency.
A decision fully priced in by markets
On December 19, 2025, the Bank of Japan’s Policy Board unanimously decided to raise the policy rate to 0.75%, the highest level since 1995. While historically significant, the move came as no surprise to financial markets. Investors were well prepared: the overnight index swap (OIS) market had priced in the hike with near 100% probability ahead of the meeting.
As a result, the classic market mechanism of “buy the rumor, sell the news” came into play. Investors who had positioned for yen appreciation ahead of the decision moved to take profits once the announcement was made, generating selling pressure on the currency immediately afterward.
USD/JPY reaction contrary to expectations
At the same time, investor attention was focused on the United States. For many months, the Federal Open Market Committee refrained from cutting interest rates due to concerns that inflation could reaccelerate amid tariff policies implemented by the Donald Trump administration. From December 2024 through September 2025, the Fed maintained its benchmark rate in the 4.25–4.50% range.
