Japan Central Bank Rate Hike To Three-Decade High Imminent, How Will The Market Go? Which Assets Most Affected?

TradingKey - As global monetary policy divergence enters a critical phase, the Bank of Japan (BoJ) is anticipated to raise its benchmark interest rate at the monetary policy meeting on December 19, 2025, by 25 basis points to 0.75% , marking its highest level in nearly 30 years.

Market consensus suggests that this rate hike decision will very likely pass unanimously, signaling the Bank of Japan's increased confidence in its inflation stability targets. BoJ Governor Kazuo Ueda had previously sent clear signals of a rate hike, and supported by robust economic data, the increase is considered almost a "done deal."

Currently, investors are primarily focused on how the Bank of Japan will outline its future interest rate trajectory in its upcoming policy guidance.

Driven by escalating market expectations, Japan's 2-year government bond yield reached a new high since 2008, while the Nikkei 225 stock index also experienced significant volatility amidst rate hike expectations.

【Historical Changes in Japan's 2-Year Government Bond Yield, Source: sc.macromicro.me】

Why is Japan's rate hike so significant? How will markets adjust?

I. The Significance of Rate Hikes Amidst Global Monetary Divergence

For over two decades, Japan has maintained an ultra-loose monetary policy, with interest rates held near historic lows to stimulate inflation and economic growth. However, with persistent core inflation above target levels, a tight labor market, and improving wage growth momentum, the Bank of Japan has begun a gradual shift towards policy normalization. This rate adjustment is not merely a change in nominal figures; it also symbolizes the BoJ's acknowledgment of sustained inflation and economic resilience.

Concurrently, the United States is nearing the end of its rate-cutting cycle, while the European Central Bank and the Bank of England are at different junctures in their monetary policy paths. This divergence in policy directions among major global central banks will further underscore the yen's role in international currency markets.

II. Immediate Reactions in Yen, Equity, and Bond Markets

Rate hike expectations previously triggered a "double whammy for stocks and bonds" scenario in the market: the Nikkei 225 index saw a significant decline, while the Japanese yen strengthened against the US dollar, and government bond yields rose sharply. This reflected market participants' concerns about Japan's unique "interest rate normalization risk" and asset price revaluation. Rising cash rates imply increased bond duration risk, putting pressure on bond prices. Concurrently, hedge funds and carry trade strategies could reverse, leading to rapid capital repatriation and creating new pressure on risk assets.

It is noteworthy that an appreciating yen has complex implications for an export-oriented economy. On one hand, a strong yen reduces export companies' earnings and weakens their international competitiveness; on the other hand, lower import costs can alleviate some inflationary pressures. This effect is particularly sensitive in industrial sectors, especially in supply chains represented by the automotive manufacturing industry, directly impacting wage negotiations and corporate profits.

The Japanese Automobile Workers' Unions Confederation issued a warning, stating that if this rate hike leads to a rapid appreciation of the yen, it could erode the profits of export-oriented companies, thereby making it difficult for upcoming wage negotiations to achieve substantial pay raise targets, highlighting the pressure of rising corporate costs faced by Japan's real economy.

III. Chain Reactions in Global Markets

Japan's rate hike spillover effects are gradually becoming apparent in global markets. Traditionally, the "yen carry trade" in the Japanese market has been enormous, with borrowing low-interest yen to invest in high-yield global assets being a crucial international capital allocation strategy. If yen yields rise, this arbitrage space could narrow or even reverse, potentially leading to a re-pricing of risk assets.

In the bond market, a narrowing Japan-U.S. interest rate differential will impact global bond yields curves, particularly in the U.S. market. A BoJ rate hike could weaken investor demand for foreign bonds, thereby pushing up government bond yields in markets such as the U.S. and increasing global financing costs.

The crypto market is also feeling the pressure. Analyst 0xNobler warns that every time Japan raises interest rates, Bitcoin drops by 20% to 25%. Next week, Japan is set to raise rates by another 25 basis points. If this pattern continues, Bitcoin could experience a significant correction.

IV. Uncertainty Regarding the Future Policy Path Remains Key for Markets

While the rate hike is a foregone conclusion, the market's primary focus is on the future trajectory of further increases. The Bank of Japan is adopting a gradual approach to its rate hike pace, aiming to avoid excessive tightening that could hinder economic growth, while also preventing excessive monetary easing from exacerbating yen depreciation and imported inflation. Kazuo Ueda's communication style and the central bank's future assessment of the "neutral rate" " will be crucial indicators for market participants to gauge the next steps.

In the medium to long term, the Bank of Japan is likely to maintain gradual rate hikes during the 2026-2027 period, but this will heavily depend on the sustained momentum of inflation, wages, and global economic growth.