Divergence in central bank policies triggers currency market explosion! The European and Japanese central bank meetings will reshape the USD trend in the second half of the year.

Central Bank Decision Week Approaching, Currencies Face Significant Volatility

This week, the foreign exchange market enters a critical decision period. The European Central Bank’s interest rate decision on December 18 and the Bank of Japan’s on December 19 will profoundly influence the next phase of the US dollar, euro, and yen trends. Last week, the US dollar index retraced 0.60%, while the euro and pound rose by 0.84% and 0.34% respectively, and the yen slightly declined by 0.29% — behind these fluctuations is the market’s re-pricing of multiple central banks’ policy expectations.

Fed Signals Dovishness, How Will the ECB Respond?

The Federal Reserve cut interest rates by 25 basis points as expected last week but announced the initiation of the Reserve Management Purchase (RMP) program, purchasing $40 billion in short-term government bonds monthly. This move is widely interpreted as a quantitative easing signal. Coupled with Powell’s dovish tone in his speech, the US dollar came under pressure and declined. More notably, the latest dot plot shows the Fed plans only one rate cut by 2026, which diverges significantly from market expectations of two cuts.

This policy uncertainty provides upward momentum for EUR/USD. Last week, the pair rose 0.84%, and this week’s ECB decision will be a key catalyst. The market expects the ECB to keep rates unchanged, but the content of President Lagarde’s speech and quarterly forecasts are more critical — investors will look for clues on when the ECB might shift toward tightening policy.

Morgan Stanley’s latest forecast indicates that the divergence in monetary policy between Europe and the US will push EUR/USD to 1.23 in the first quarter of 2026. On the technical side, EUR/USD has broken above the 100-day moving average, with RSI and MACD indicators still showing strong bullish momentum. The next target is 1.18, with resistance at the previous high of 1.192. If the price pulls back, support is expected around the 100-day moving average at 1.164.

US November non-farm payroll data will also influence the short-term direction of EUR/USD — if below expectations, the dollar will weaken further, and EUR/USD will continue to rise; otherwise, it may face short-term resistance.

Bank of Japan Rate Hike Imminent, Can Yen Turn the Tide?

USD/JPY rose 0.29% last week, but behind this seemingly moderate gain lies significant market disagreement. On December 19, the Bank of Japan will announce its interest rate decision, with widespread expectations of a 25 basis point hike to 0.75% — the highest level in Japan in 30 years.

However, the market has already fully priced in the rate hike itself. The real focus is on Governor Ueda’s stance on the future rate path, especially his views on the “neutral rate.” Nomura Securities believes Ueda may keep his wording vague to preserve policy flexibility and is unlikely to signal a hawkish rate hike beyond market expectations.

U.S. bank analysts suggest that if the BOJ signals a “dovish rate hike,” USD/JPY could stay high or even push toward 160 early next year. Conversely, if a “hawkish rate hike” is indicated, short positions on the yen may be covered, and USD/JPY could fall back to 150 — though the latter scenario is less likely.

On the technical side, USD/JPY has broken below the 21-day moving average. Continued pressure below this line increases downside risk, with support around 153. Conversely, if it reclaims the 21-day moving average, resistance is seen at 158.

Key Turning Point for the US Dollar in the Second Half of the Year

This week’s central bank decision week marks a crucial turning point for the US dollar’s performance in the second half of the year. The policy stances of the ECB and BOJ will contrast sharply with the dovish tilt of the Fed, influencing the dollar’s next phase. If non-farm payrolls come in below expectations, the dollar may accelerate its decline; if above, a short-term rebound is possible. However, in the medium term, the divergence in US and European monetary policies is set, supporting the euro’s relative strength. The yen’s trend will depend more on how the BOJ balances rate hikes with economic growth considerations.

Market participants should closely monitor this week’s ECB meeting, BOJ decision, and US non-farm payroll data, as these three events will shape the volatility landscape for the dollar, euro, and yen in the coming months.