Summary:
The Japanese yen has fallen to a near 40-year low due to the wide US-Japan interest-rate gap, carry trade activity, and rising energy import costs. While Japan has intervened in currency markets and raised rates, high public debt limits more aggressive policy action. A weaker yen supports exporters but increases import costs, leaving policymakers with a difficult balancing act.
The Japanese yen’s slide to its weakest level in around four decades has highlighted the limits facing Japan’s policymakers as they try to stabilise the currency without disrupting economic growth and financial markets. The yen recently breached 160 against the US dollar, reaching levels last seen in 1986, despite repeated intervention and monetary tightening by the Bank of Japan. Japan and the US subsequently carried out a rare coordinated yen-buying intervention, helping the currency recover from its extreme lows, although concerns over its longer-term weakness remain.
Yen Has Lost More Than 50% in Five Years
The deterioration has been steep. The average yen exchange rate in Tokyo has weakened from roughly 103 against the US dollar in January 2021 to around 163 in July 2026, representing a depreciation of more than 50%.
The weakness is not restricted to the US dollar. In July, the yen traded around 219.6 against the British pound and approximately 198.6 against the euro, while also weakening against currencies including the Australian and New Zealand dollars.
Wide US-Japan Interest Rate Gap Keeps Yen Under Pressure
The biggest structural pressure comes from the wide interest-rate differential between Japan and the US. The Bank of Japan raised its benchmark rate to 1% in June, its highest level since the 1990s. However, US interest rates remain significantly higher at around 3.5%-3.75%.
Japan’s 10-year government bond yield has risen sharply from around 0.4% in early 2023 to 2.6% in the second quarter of 2026, but it remains well below the roughly 4.4% yield on 10-year US government bonds.
This difference encourages the yen carry trade, where investors borrow cheaply in Japan and invest in higher-yielding overseas assets. The resulting yen selling continues to put downward pressure on the currency.
Energy Imports Add to Japan’s Currency Problem
Japan’s dependence on imported energy has made the situation more difficult. The country imports almost all its crude oil and natural gas, with more than 90% of crude oil imports coming from West Asia. A substantial share also passes through the Strait of Hormuz, leaving Japan vulnerable to geopolitical disruptions.
Japan recorded a trade deficit of around 391.8 billion yen in May, before returning to a surplus of approximately 406.9 billion yen in June. Since energy imports are largely priced in US dollars, a weaker yen increases import costs, which can further weaken the trade balance and reinforce currency depreciation.
Why Can’t the Bank of Japan Raise Rates Aggressively?
Japan’s decades of unconventional monetary policy have left the central bank with an exceptionally large balance sheet. By December 2025, Bank of Japan assets had reached around 102.2% of GDP, reflecting years of large-scale government bond purchases.
Rapid rate hikes could push government bond yields sharply higher, reduce bond prices and increase financing costs across an economy carrying substantial public debt. This limits how aggressively the central bank can tighten monetary policy simply to defend the yen.
Why Did Japanese Stocks React to the Yen Movement?
A weak yen can support Japanese exporters because overseas earnings translate into more yen and Japanese products become more competitive internationally. This has periodically supported automobile, machinery and other export-oriented stocks. Conversely, a sharp yen recovery following intervention can pressure exporter shares because the currency benefit shrinks. Japan’s policymakers therefore face a difficult trade-off: excessive yen weakness raises household and import costs, while aggressive measures to strengthen it can create pressure across bonds, equities and the broader economy.
