The mystery of the yen's continued depreciation despite narrowing interest rate gap between Japan and the US

The long-held belief that “narrowing interest rate differentials lead to yen appreciation” has become invalid in the foreign exchange market. Since 2025, the U.S. has cut interest rates while Japan has raised them, reducing the policy interest rate gap between Japan and the U.S. to its lowest level in about three years. However, the yen remains around 155 yen per dollar, roughly unchanged since the beginning of the year. What is the key to understanding the “mystery” of the yen’s continued depreciation despite the narrowing interest rate gap?

The Bank of Japan will hold a monetary policy meeting on December 18-19 to discuss raising the policy interest rate. Market forecasts suggest a 95% probability of a rate hike at the December meeting.

The U.S. Federal Reserve (Fed) decided to cut interest rates three consecutive times at its December Federal Open Market Committee (FOMC) meeting. If the Bank of Japan decides to raise rates, the policy rate differential between Japan and the U.S. will shrink to its smallest level in about three years. Currently, the real interest rate differential has narrowed to its lowest point in about two and a half years. Generally, rising Japanese interest rates and falling U.S. interest rates lead to a narrowing of the interest rate differential, which tends to cause the yen to appreciate against the dollar.

To continue reading, click here to visit the Nikkei Chinese website.

The Nikkei and the Financial Times merged in November 2015 to form a single media group. This alliance, formed by two newspapers from Japan and the UK founded in the 19th century, is committed to “high-quality, comprehensive economic news” and promotes collaboration across various fields, including special features. As part of this effort, the Chinese-language websites of both newspapers now exchange articles.