The Central Bank Game Behind Exchange Rate Fluctuations: Can Rate Hikes and Currency Appreciation Be Achieved Simultaneously? [Forex Weekly Report]

Last Week’s Market Highlights

From December 15 to 19, the US dollar index rose slightly by 0.33%, while non-US currencies showed mixed performance. The Japanese yen was the hardest hit, declining by 1.28%, the Australian dollar fell by 0.65%, the euro slightly declined by 0.23%, and the British pound rose against the trend by 0.03%.

Diverging Euro Trends: The Tug-of-War Between Rate Hikes and Economic Recovery

EUR/USD fluctuated last week, ending down by 0.23%. The European Central Bank maintained interest rates as planned, but President Lagarde did not deliver the hawkish signals expected by the market, disappointing investors.

US data was mixed. November non-farm payrolls and consumer price index figures fell short of expectations. However, major investment banks like Morgan Stanley and Barclays warned that these figures might be influenced by technical factors and statistical distortions, making it difficult to accurately reflect the true economic trajectory. The market currently anticipates two rate cuts by the Federal Reserve by 2026, with a 66.5% probability of a cut in April.

Institutions are optimistic about the euro’s appreciation. Danske Bank pointed out that as the US dollar faces pressure from the Fed’s potential rate cuts and the European Central Bank maintains stable rates, the real interest rate differential after inflation adjustment is expected to narrow, which would favor euro appreciation. Additionally, the recovery of European asset markets, rising demand for safe-haven assets amid US dollar depreciation risks, and declining confidence in US policies could all support the euro.

This Week’s Trading Focus: Pay attention to US Q3 GDP data. If the data exceeds expectations, it will be bullish for the dollar and bearish for the euro; otherwise, it will favor EUR/USD. Technically, EUR/USD remains above multiple moving averages, with short-term upside potential. Resistance is around 1.18; support is at the 100-day moving average near 1.165.

Japanese Yen Plummets: Rate Hike Fails, Currency Appreciation Difficult

USD/JPY rose by 1.28% last week, mainly due to the limited effect of the Bank of Japan’s “moderate rate hike” policy.

The BOJ raised interest rates by 25 basis points as scheduled, but Governor Ueda’s comments were cautious, disappointing market expectations of tightening. Meanwhile, Prime Minister Suga’s cabinet approved a large fiscal support package of up to 18.3 trillion yen, further offsetting the contractionary effects of the rate hike. The market currently predicts only one rate cut by the BOJ in 2026. Sumitomo Mitsui Banking Corporation estimates the next rate hike could be as early as October 2026, with the yen potentially weakening to 162 by the first quarter of 2026.

However, JPMorgan issued a warning: if the yen depreciates beyond 160 in the short term, it could trigger rapid exchange rate movements, increasing the likelihood of government intervention. Nomura Securities holds a different view, believing that under the Fed’s rate cut cycle, the dollar will eventually weaken further, making it difficult for the yen to depreciate again. They forecast the yen will appreciate to 155 in the first quarter of 2026.

Key Signals This Week: Watch for speeches by BOJ Governor Ueda and official statements on verbal interventions in the forex market. If speeches lean hawkish or government intervention escalates, USD/JPY could face downside pressure. On the technical side, USD/JPY has broken above the 21-day moving average, and MACD has shown a buy signal. A break above resistance at 158 could open up more room for gains; if it faces resistance below 158, the risk of a pullback increases, with support at 154.

Summary: The core contradiction in the forex market this week lies in the disconnect between central bank policies and economic realities. The euro faces a narrowing interest rate differential but remains fundamentally stable, with a relatively optimistic outlook for appreciation. The yen, on the other hand, is caught in a situation where rate hike effects are limited and policy intervention risks loom, making appreciation challenging. Close attention should be paid to US GDP data and Japanese official developments.