Why Is the Yen So Weak? Key Factors Explained

The Japanese Yen has experienced significant depreciation against major global currencies in recent times. This sustained weakness has drawn attention from financial observers. Understanding the underlying reasons for this phenomenon requires examining several interconnected economic factors. This article will explore the key elements contributing to the yen’s current valuation.

Monetary Policy Divergence

A primary factor contributing to the yen’s weakness is the significant divergence in monetary policy between the Bank of Japan (BOJ) and other major central banks. For an extended period, the BOJ maintained an ultra-loose monetary stance to combat deflation and stimulate economic growth. This included implementing negative interest rates and employing Yield Curve Control (YCC), a policy designed to keep long-term government bond yields at very low levels, typically around zero percent.

While the BOJ made a shift in March 2024, ending its negative interest rate policy and abolishing YCC, its new short-term interest rate target of 0% to 0.1% still represents a highly accommodative stance. The BOJ has indicated that its monetary policy remains much looser than that of most developed nations, emphasizing patience in further policy normalization. This contrasts sharply with the actions of central banks in other large economies, such as the U.S. Federal Reserve and the European Central Bank.

These central banks embarked on aggressive interest rate hiking cycles in response to rising inflation. For instance, the U.S. Federal Reserve’s benchmark interest rate has been significantly higher than Japan’s, creating a substantial interest rate gap. This difference has created a strong pull on currency values. The BOJ’s accommodative stance effectively increases the supply of yen relative to other currencies, contributing to its depreciation.

Interest Rate Differentials

Building on the differing monetary policies, a substantial gap in interest rates has emerged between Japan and many other countries. This interest rate differential refers to the difference in borrowing and lending rates across economies. When one country offers significantly higher interest rates than another, it tends to attract foreign investment.

Investors seeking better returns are inclined to move their capital to countries where they can earn more on their investments. This increased demand for the higher-yielding currency leads to its appreciation, while the lower-yielding currency, the yen, experiences downward pressure.

This dynamic is clearly illustrated by the “carry trade,” a common investment strategy. In a carry trade, investors borrow money in a low interest rate currency, like the Japanese yen, and then invest in assets denominated in a higher-yielding currency. The goal is to profit from the interest rate difference, provided the exchange rate does not move unfavorably. This practice directly increases the supply of yen in foreign exchange markets as investors sell yen to acquire other currencies, further contributing to its depreciation.

Trade Dynamics and Energy Prices

Japan’s economic structure, particularly its reliance on imports, plays a role in the yen’s valuation, especially in the context of global commodity prices. Japan is a major net importer of energy and raw materials, with limited domestic resources for oil and natural gas.

When global energy and commodity prices rise, Japan’s import bill increases substantially. A weaker yen exacerbates this situation, as more yen are required to purchase the same amount of foreign goods and services. This dual impact of higher global prices and a depreciating currency inflates the cost of essential imports for Japan.

The result is often a widening trade deficit or a shrinking trade surplus, meaning Japan is spending more on imports than it is earning from exports. This imbalance indicates that a larger volume of yen is being sold in foreign exchange markets to finance these imports, while demand for yen from export earnings is comparatively lower. This continuous selling pressure on the yen contributes to its ongoing depreciation.

Global Economic Environment and Investor Sentiment

Broader global economic conditions and prevailing investor sentiment also influence the yen’s value. Historically, the yen has often been considered a “safe-haven” currency, meaning investors flock to it during times of global economic uncertainty or market turmoil. In such periods, the yen strengthens as investors seek its perceived stability.

However, in times of perceived global stability or economic growth, the yen might weaken. This occurs as investors become more willing to take on risk, seeking higher returns in riskier assets, moving away from traditional safe havens. The yen’s role as a funding currency for carry trades means it can weaken when global liquidity is abundant and interest rate differentials are wide.

Perceptions regarding Japan’s long-term economic growth prospects and ongoing demographic challenges, such as a shrinking and aging population, can also influence investor sentiment. While not immediate drivers, these structural issues can shape long-term views on the yen’s potential, contributing to a cautious outlook among some international investors. These broader global factors, alongside the specific monetary and trade dynamics, collectively impact the yen’s trajectory.