JPY Plunges as Japan's "Record Budget" Undercuts BOJ Hike

Japan‘s currency is facing renewed selling pressure as Prime Minister Sanae Takaichi’s government unveils a record-breaking fiscal package, effectively neutralizing the market impact of the Bank of Japans (BOJ) historic pivot away from ultra-loose monetary policy.

Despite the BOJ raising rates by 25 basis points to 0.75%—a 30-year high—the Yen has weakened, with USD/JPY breaching 157. Traders are focusing on the fiscal deterioration implied by the new 122.3 trillion yen ($815 billion) budget for fiscal year 2026, creating a contradictory “fiscal expansion vs. monetary tightening” dynamic.

Fiscal Dominance Overshadows Monetary Policy

The budget, representing a 6.3% increase from the previous year, is driven by structural swelling in social security costs and a surge in defense spending to 8.8 trillion yen. While tax revenues are projected to hit a record high, they cover only a portion of expenditures, raising concerns about long-term debt sustainability in a nation where debt-to-GDP already exceeds 263%.

“Investors are no longer looking at the yield differential alone,” notes Rikiya Takebe, Senior Strategist at Okasan Securities. “The focus has shifted to fiscal credibility. The aggressive fiscal expansion is eroding trust in the Yen, particularly among overseas investors concerned about sustainability.”

Market Reaction: The “Sell the Fact” Trade

The market response to the BOJ's December 19 hike was counterintuitive but telling. Instead of strengthening, the Yen fell, validating the view that a 75bps policy rate is insufficient to offset the inflationary pressure of massive government spending.

• USD/JPY: Surged from 155 to over 157 post-announcement.
• Policy Conflict: The BOJ is stepping on the brakes while the government slams on the gas.

Government officials, including Finance Minister Satsuki Katayama, have issued verbal warnings about “speculative moves,” hinting at intervention. However, with the fundamental drivers of weakness now rooted in fiscal policy rather than just interest rate differentials, FX intervention may prove less effective than in previous cycles.