2026-07-06
Yen Falls Below 162 to a 40-Year Low as Rate Hikes Fail to Curb Carry Trades and Intervention Risks Rise
The yen’s depreciation has once again become a major focus in global foreign exchange markets. From late June to early July, USD/JPY once climbed above 162, touching around 162.84, a 40-year low and a level beyond the key range where Japan had previously intervened in the foreign exchange market. Although the Bank of Japan raised its policy rate to 1.0% on June 16, the highest level since 1995, the yen did not stop weakening. Instead, it continued to face depreciation pressure as the U.S.-Japan interest rate differential remained wide, carry trades persisted, and concerns over Japan’s fiscal outlook intensified.
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The core reason behind the yen’s weakness still lies in the contradiction between monetary policy and fiscal policy. The Bank of Japan raised rates mainly because imported inflation pressure has been rising, as the weak yen pushes up the cost of imported energy, food, and raw materials, forcing the central bank to accelerate policy normalization. However, markets also expect the Federal Reserve to maintain a hawkish stance as inflation remains above target, making it difficult for the U.S.-Japan interest rate gap to narrow quickly. At the same time, the Takaichi cabinet’s continued expansionary fiscal stance has heightened investor concerns over Japan’s large public debt and long-term fiscal discipline, further weakening the yen’s appeal as a safe-haven currency.
From the perspective of market positioning, the yen remains an important funding currency for global carry trades. Investors borrow low-yielding yen and shift funds into higher-yielding assets such as U.S. dollar assets, Indian equities, and the Turkish lira, keeping selling pressure on the yen. Even though the Japanese government spent about 11.73 trillion yen on foreign exchange intervention from late April to late May, briefly pulling the yen back toward the 155 level, the effect did not last. Recently, markets have even begun discussing tail risks of USD/JPY rising toward 170, 180, or even 200. However, 200 is not the base-case scenario; it would require several conditions to occur simultaneously, including a more hawkish Fed, another surge in oil prices, worsening confidence in Japan’s fiscal position, and ineffective official intervention.
The impact of yen depreciation on Japan’s economy is clearly divided. On one hand, a weaker yen supports earnings for export-oriented companies and has helped lift the Nikkei index to elevated levels, with external-demand sectors such as semiconductors, machinery, and automobiles benefiting significantly. Japan’s exports rose 17.0% year over year in May, while overseas machinery orders also remained at a high growth rate, reflecting continued support for Japan’s manufacturing sector from the AI supply chain and global capital expenditure demand. On the other hand, yen depreciation pushes up import costs, with price pressures spreading across food, energy, and electricity. This weighs on Japanese households’ real purchasing power and consumer confidence, while also raising political risks for the government as it faces rising living-cost inflation.
Looking ahead, markets will focus on three key areas over the coming months. First, if USD/JPY stays firmly above 162 and tests the 164 to 165 range, the probability of renewed intervention by the Japanese government will rise. Second, if the Federal Reserve keeps interest rates high while the Bank of Japan raises rates only gradually, the U.S.-Japan interest rate differential will continue to support short-yen trades. Third, if yen depreciation further fuels imported inflation, the Bank of Japan will face an even more difficult policy trade-off. In the short term, official intervention may slow the pace of yen depreciation. However, if interest rate differentials, fiscal concerns, and energy import pressures do not improve, the weak-yen trend will remain difficult to fundamentally reverse.