Can the Japanese Yen reverse its downward trend? The central bank's decision week faces a critical test

This week, the financial markets will welcome two major central bank meetings— the Bank of Japan (December 19) and the European Central Bank (December 18)—which will announce their interest rate decisions consecutively. Influenced by the Fed’s policy shift, the currency market landscape has quietly changed, and the yen and euro will face a new round of reshuffling.

The Bank of Japan’s rate hike imminent, yen rebound with variables

Rate hike is a certainty; the real test comes from “hints”

The market generally expects the Bank of Japan to announce a 25 bps rate increase to 0.75% this Wednesday, marking a 30-year high. However, the rate hike itself has already been priced in, and what truly determines the yen’s movement will be Governor Ueda Kazuo’s wording regarding future policy paths—especially how he defines the “neutral interest rate” level.

Nomura Securities analysts believe Ueda will maintain a vague stance to keep flexibility for subsequent policies. This suggests that this meeting is unlikely to signal an unexpectedly hawkish tone, and the market should not expect more aggressive rate hike hints.

Dual expectations for exchange rate trends

U.S. banks point out that the tone of the rate hike is crucial. If the central bank signals a “dovish” moderate rate increase, USD/JPY will remain high, possibly approaching 160 early next year. Conversely, if a “hawkish” aggressive rate hike is hinted, it could trigger short covering and push USD/JPY back toward 150. However, the latter scenario is less likely.

Technical outlook shows weakness

Last week, USD/JPY rose 0.29%, but technical signals have appeared. USD/JPY broke below the 21-day moving average; if it remains pressured below this line, the decline could accelerate, with recent support around 153. Conversely, if it recovers above the 21-day moving average, resistance will be at 158.

Fed’s dovish shift, euro gains momentum

Dollar index loses support

Last week, the dollar index fell 0.60%, while EUR/USD rose 0.84%. The fundamental reason for this rally is the adjustment in Fed policy expectations. Although the Fed cut rates by 25 bps as planned, it also announced the initiation of the Reserve Management Purchase (RMP) program, purchasing $40 billion of short-term government bonds monthly, which market interprets as a prelude to a new round of quantitative easing. Chairman Powell’s dovish tone further contributed to the dollar’s sharp decline over two days.

It is worth noting that the latest Fed dot plot indicates only one rate cut by 2026, but the market still bets on two cuts this year. This divergence in expectations will be an unstable factor for the dollar’s future trend.

ECB remains on hold, Lagarde’s speech in focus

The European Central Bank is expected to keep rates unchanged. Market focus shifts to President Lagarde’s comments and the latest quarterly forecasts to track when a new policy cycle might begin. Morgan Stanley predicts that, amid diverging monetary policies between Europe and the U.S., EUR/USD will rise to 1.23 in the first quarter of 2026.

Technical indicators remain bullish

EUR/USD has broken above the 100-day moving average, with RSI and MACD indicators showing strong bullish momentum. The next target is 1.18; if broken, resistance shifts to the previous high of 1.192. If short-term highs retreat, support will be around 1.164 near the 100-day moving average.

This week’s decision schedule and market expectations

Central bank decisions are the core drivers

The ECB meeting on December 18 and the Bank of Japan meeting on December 19 will be the main market indicators. Additionally, the U.S. November non-farm payrolls data should not be overlooked. Weak data could further weaken the dollar, boosting EUR/USD and supporting the yen. Conversely, better-than-expected non-farm data could put short-term pressure on EUR/USD.

Yen outlook depends on central bank language

The policy expectations of the BOJ and Fed will be key factors in determining USD/JPY movement. If the BOJ hints at a gradual pace of future hikes, USD/JPY will likely remain strong. If more aggressive rate hike signals are given, the yen could see a significant rebound.

Can the euro continue its rally?

The ECB’s wording and the market’s reassessment of the timing of rate cuts in Europe in 2026 will determine whether the euro can sustain its upward momentum this week.