Rate Hikes and U.S.–Japan Intervention Fall Short as Weak Growth and Fiscal Strains Push a Yen Recovery Further Out of Reach

Weak growth and deteriorating public finances constrain monetary tightening and the pace of rate hikes
Lower returns than in the U.S. and overseas earnings retained abroad leave little demand for yen purchases
A fragile foundation for a yen rebound puts Japan’s economic fundamentals in focus

The yen’s weakness has proved difficult to reverse despite interest-rate increases by the Bank of Japan and coordinated intervention by U.S. and Japanese foreign-exchange authorities. The interest-rate gap with the United States remains wide, while slowing growth and fiscal pressures limit Japan’s scope for further tightening. Demand for dollars to cover the trade deficit persists, and overseas investment earnings remain abroad, weakening the basis for yen purchases. As Japan’s economic standing diminishes, analysts say sustaining the yen’s value will require gains in productivity and investment appeal.

UBS: “Official Intervention Is an Opportunity to Sell the Yen”

According to Bloomberg on September 22 (local time; all dates below are local), Kevin Zhao, head of global fixed income at UBS Asset Management, said of the prospect of further yen-buying intervention by Japanese authorities: “If the authorities intervene in the market to support the yen, it will be the best opportunity to sell it.” His reasoning is that the Bank of Japan’s rate increases are not hawkish enough to change the foreign-exchange market’s direction. Zhao said the central bank is raising rates more slowly than markets had expected and that its moves are insufficient to halt the currency’s persistent decline.

The pronounced interest-rate gap between the United States and Japan is widely cited as the principal driver of yen weakness. Although the U.S. Federal Reserve (Fed) shifted toward rate cuts, it has maintained a relatively high policy rate. The Bank of Japan, meanwhile, faces constraints on rapid rate increases because of Japan’s enormous public debt. With the real interest-rate differential between the two countries failing to narrow, the incentive to sell yen and buy dollars through the yen carry trade remains strong. Zhao warned that if the U.S.–Japan rate gap persists, the yen could again fall to about $0.00610, the level it reached when a dollar bought approximately 164 yen.

Yen Weakness Persists Despite Joint U.S.–Japan Intervention, Prompting Further BOJ Tightening

With the U.S.–Japan interest-rate gap showing little sign of narrowing, the effect of yen-buying intervention was also short-lived. Coordinated intervention by the two countries in late July lifted the yen to around $0.00637, but by August 31 it had fallen below $0.00625, reaching approximately $0.00625. As the prospect of a U.S. rate increase grew, dollar buying resumed and erased much of the yen’s intervention-driven gains. At the time, The Wall Street Journal (WSJ) reported experts’ view that yen strength would be difficult to sustain without a shift in Japanese monetary policy. Even intervention backed by the United States could not readily reverse capital flows driven by the interest-rate differential.

As yen weakness persisted after the intervention and inflationary pressure mounted, the Bank of Japan raised rates again. On September 18, it lifted its policy rate from 1.0% to 1.25% a year, tightening for the second time in three months after its June increase. The rate reached its highest level in 31 years, since 1995. According to Reuters, the Bank of Japan judged that rising prices in transactions between businesses had begun feeding through to consumer prices. Governor Kazuo Ueda also stressed the need to act preemptively against the risk that underlying inflation would exceed the 2% target. U.S. Treasury Secretary Scott Bessent’s call for decisive monetary-policy action to counter yen weakness added to the pressure against delaying the increase.

Table 1. Economic Conditions Making Yen Weakness Difficult to Reverse

Slowing Growth and Mounting Fiscal Pressure

Yet Japan’s economic fundamentals are too fragile for a 0.25-percentage-point rate increase alone to reverse yen weakness. In July, the government lowered its fiscal 2026 forecasts for both real growth and private-consumption growth from 1.3% to 0.9%. It also cut its forecast for growth in capital investment from 2.8% to 2.3%, weakening expectations of increased corporate spending. At the same time, its consumer-inflation forecast, revised to reflect higher energy prices, rose from 1.9% to 2.2%, pointing to a heavier price burden amid slower growth. With high oil prices eroding household purchasing power and corporate earnings, rapid rate increases risk further suppressing consumption and investment.

A fiscal policy that combines tax cuts with higher spending has added to the constraints on further tightening. Prime Minister Sanae Takaichi’s Cabinet plans to lower the consumption-tax rate on food from 8% to 1% for two years beginning next April, but it has not specified how it will cover the resulting revenue shortfall of approximately $31.3 billion. As population aging drives up pension and welfare spending, principal and interest payments on government bonds in next year’s budget requests have reached a record $229 billion, up $33.5 billion from this year. The Bank of Japan, which must weigh a recovery in domestic demand against fiscal sustainability, is therefore poorly placed to press ahead with rate increases solely to defend the yen.

External trade has likewise offered little improvement in the conditions supporting the yen. Japan recorded a trade deficit of approximately $10.6 billion in fiscal 2025, which ended in March, marking its fifth consecutive annual deficit. U.S. tariffs contributed to a 16% decline in Japanese automobile exports to the United States and a 6.6% drop in its overall exports to that market. More recently, a rising energy-import bill has further obstructed an improvement in the trade balance. Although exports in August rose 19.3% from a year earlier, imports increased 28%, leaving a trade deficit of approximately $6.88 billion, the fourth consecutive monthly shortfall. In Japan, which relies heavily on imported crude oil, higher oil prices increase demand for dollars to settle purchases and intensify pressure to sell yen.

Record Current-Account Surplus Fails to Support the Yen as Overseas Earnings Stay Abroad

As yen weakness raises prices in Japan, its potential effects on trading partners have also become a concern. If Japanese companies use the exchange-rate advantage to lower export prices, competitors in South Korea, the United States and China may face pressure to cut their own prices. The United States must also consider the implications for its financial markets. If Japanese authorities sell U.S. Treasuries to fund yen-defending intervention, or Japanese investors dispose of U.S. assets to bring capital home, U.S. Treasury yields could face upward pressure. The Financial Times (FT) reported a market interpretation that U.S. participation in coordinated yen purchases was intended in part to discourage Japanese sales of Treasuries. Within Japan, the costs of a weaker yen have accumulated among companies unable to pass higher import costs on to customers and households facing rising living expenses.

Overseas investment earnings that could support the yen have not returned to Japan in sufficient amounts. In 2024, Japan recorded a primary-income surplus of approximately $251 billion, including dividends and interest earned on overseas investments. It was the main factor offsetting the trade deficit and lifting the current-account surplus to a record approximately $183 billion. Much of the money earned abroad, however, was reinvested locally, limiting the amount converted into yen. Earnings retained rather than distributed by overseas subsidiaries are also recorded as reinvested earnings in balance-of-payments statistics. Consequently, a larger current-account surplus does not generate an equivalent increase in yen buying in the foreign-exchange market.

Companies’ and investors’ assessments of returns help explain the slow repatriation of overseas earnings. Takeshi Minami, chief economist at the Norinchukin Research Institute, noted that when overseas investments yield more than investments in Japan, there is little incentive to bring funds home. Companies expecting the yen to decline further have little reason to rush into conversion, either: by holding dollars until the yen falls further, they can obtain more yen for the same dollar amount. Working-capital requirements for local operations and demand for additional investment strengthen the incentive to leave overseas earnings where they are. A brief yen rebound following official intervention is unlikely to alter companies’ medium- and long-term capital-allocation plans.

Japan’s Diminished Economic Standing Tests Recovery in Yen Demand

Rising U.S. interest rates provide a further incentive to keep holding dollars. As expectations of additional Fed tightening took hold, the yield on the two-year U.S. Treasury note rose to 4.741% on September 18, its highest level since July 2024. If U.S. rates rise alongside Japanese rates, Japan’s ability to attract funds from abroad will remain limited. This consideration also appears to have informed Treasury Secretary Bessent’s call for a decisive Japanese monetary-policy response. Unless Japan can raise returns on yen-denominated assets sufficiently, even a currency-defense effort joined by the United States may be overwhelmed by private-sector demand to hold dollars.

Japan’s economic standing, long a source of demand for the yen, is no longer what it was. Masato Kanda, president of the Asian Development Bank (ADB), said at a Yomiuri international economic forum in Tokyo on September 16 that “no one thinks of Japan as a superpower anymore.” He was referring to Japan’s share of the Asia-Pacific economy, which fell from more than half in 2000 to around 10% in 2025. Over the same period, China’s share approached half, while India grew to roughly match Japan. Linking this shift in standing to yen weakness, Kanda argued that exchange rates reflect national economic strength over the medium and long term and called for higher productivity and labor-market reform. His remarks suggest that demand to hold yen can recover only if expectations for returns on investment in Japan improve. The status Japan once enjoyed as Asia’s largest economy is no longer enough on its own to attract capital.