Japan’s post-war rise made it a model of economic recovery, but the yen’s renewed weakness has exposed a deeper problem: ultra-low rates, energy dependence, weak domestic demand and high public debt are limiting Tokyo’s room for manoeuvre.
Japan was once regarded as the model of post-war economic reconstruction. Defeated, occupied and devastated by the Second World War, it rebuilt its industrial base, developed globally competitive manufacturers and became the world’s second-largest economy within a generation. Its rise became shorthand for industrial discipline, technological upgrading and export-led growth.
That history makes the present pressure on the yen more significant. Japan is not facing a sudden collapse, but a structural currency problem. The yen has weakened sharply against the dollar in recent years, and Reuters reported that Japanese authorities may have sold around $35 billion to support the currency after renewed market pressure.
The exchange rate has become a political and economic issue because yen weakness feeds directly into import costs. For foreign visitors, a cheaper yen makes Japan less expensive. For Japanese households, it raises the cost of imported food, fuel and raw materials. This is especially sensitive in an economy where real incomes are under pressure and where the country remains heavily dependent on imported energy.
The first cause is the interest-rate gap with the United States. On 28 April, the Bank of Japan kept its short-term policy rate at around 0.75 per cent, although three members of its policy board voted for an immediate rise to 1 per cent. The Federal Reserve’s policy rate remains much higher, encouraging investors to borrow in yen and place capital in dollar assets.
The second cause is energy dependence. Japan imports most of its fuel, so higher oil prices increase demand for dollars and weaken the yen. In its April outlook, the Bank of Japan said growth was likely to decelerate in fiscal 2026 because higher crude prices, linked to tensions in the Middle East, were expected to damage Japan’s terms of trade and reduce corporate profits and household real income.
The same outlook underlined the policy dilemma. The Bank of Japan’s median forecast for real GDP growth in fiscal 2026 was cut to 0.5 per cent, while its core consumer inflation forecast was raised to 2.8 per cent. That is the combination policymakers least want: weak growth with persistent price pressure.
The third factor is demography. Japan’s ageing and shrinking population weighs on domestic demand. A smaller working-age population and a larger retired population constrain consumption, while also placing pressure on public finances. This reduces the Bank of Japan’s room for aggressive tightening, because higher borrowing costs could weaken growth further and unsettle the government bond market.
Tokyo’s intervention also reflects the psychological importance of the 160 yen-per-dollar level. The yen fell to around 160.72 per dollar before rebounding sharply after suspected intervention. Reuters noted that Japan had already intervened in April and May 2024 after the currency crossed similar levels, spending a combined 9.79 trillion yen at that time.
However, intervention can only buy time. Selling dollars and buying yen may slow a currency fall, but it does not remove the underlying incentive for investors to sell yen while US rates remain substantially higher. Traders have treated yen rallies as opportunities to re-enter yen-funded positions, reflecting continued confidence in the carry trade.
The Bank of Japan is therefore caught between two risks. A sharp rise in rates could support the yen, but it could also damage a fragile economy and raise the cost of servicing public debt. The IMF’s data place Japan’s general government gross debt among the highest in the advanced world.
Leaving rates low carries its own cost. It preserves favourable conditions for borrowers, but it also sustains the carry trade and weakens confidence in the currency. That matters because Japan’s long period of ultra-loose monetary policy was designed for a low-inflation world. The present environment is different: energy prices are volatile, geopolitical shocks are feeding into import costs, and global capital is again being priced around yield.
Japan’s currency problem is therefore not simply a market episode. It is a test of whether a major advanced economy, built on cheap money, high public debt and an ageing population, can adjust to a period in which money is no longer cheap and imported inflation is harder to contain. The yen may be defended in the market, but the pressure behind its decline lies deeper than the exchange rate itself.
