Why Japanese Yen Weakening? inflation and Price Increases

The Global Role of Japanese Yen

Did you know? Japan had the third-most traded currency in the world. Is it because Japan had this massive economy scale. And for a long time, BOJ (Bank of Japan) also had a persistently low interest rate. Japan also is one of the largest creditor nations. All of this made the Japanese Yen the third-most traded currency.

What is Carry Trade Phenomenon

Why did the BOJ persistently make the interest rate low?. It is because of the “carry Trade” phenomenon. What Is it?. Let’s imagine this, you want to invest in some stocks or higher-yielding financial instruments in other countries. But, you don’t have that much money to trade it. You think to borrow some money to start it. This is when the BOJ policies step in. Assuming the short-term interest rate of the Japanese Yen is 1.0%. With that money you buy some higher-yielding fund with 4.0% rates. You can get 3.0% annualized net interest profit. So basically, you can get 3.0% interest profit while doing nothing.

From Deflation to Monetary Normalization

Why was the interest rate so low?. It all was because Japan suffered from deflation. BOJ’s decision to make the interest rate so low was to make the bank lend more and consumers spend more. For 30 years they lowered their interest rate. But because the inflation was consistently above 2%, they are trying to bring the monetary system back to normal.First, they made a policy to exit negative rates in 2024. In July 2024 the rate is going up to 0.75%. And in December of 2025 BOJ set the rate to 0.75%. But, in 2026 because of a world recent event. The BOJ raised the interest rate to 1%.

Why Are Interest rates Raising

But, why did the BOJ start doing that?. You already read that the inflation is consistently above 2%. Of course the reason is not just that. The BOJ’s main goal is “price stability”. Ultra low rates that BOJ kept made the Japanese Yen plummet against USD. It made the import cost much higher. Stability of price also made a turn in the energy sector. After 2011, Japan shut down most of its nuclear plants and imported 80% of its energy. But not just the Price Stability goal that makes the Japanese Yen plummet. It is also because of the massive outflows of domestic capital. Japan pension funds and life insurance companies put their money in overseas high-yielding funds. The retail investor also makes use of the Japan tax-free investment program (NISA) to buy foreign investment.On the Geopolitical side, imposed tariffs on Japanese products also forced Japanese Manufacturers to build factories abroad. All of these outflows make the Japanese Yen much weaker than it was before.