The Japanese yen has fallen to its weakest level in nearly four decades, breaching the 160-per-dollar mark for the first time since 1986. As the world's second most-traded currency pair, sharp dollar-yen movements have far-reaching implications for global trade and financial markets, prompting Japanese authorities—and even the US—to intervene in support of the currency.

While the yen's latest slide reflects a higher energy import bill and the wide US-Japan interest-rate differential, the currency is likely to remain under pressure unless Japan addresses deeper structural challenges, including persistent fiscal expansion and weak long-term growth. Decades of unconventional monetary easing have also constrained Tokyo's ability to raise interest rates aggressively to defend the yen without unsettling financial markets.

Steep slide

Over the past five years, the average dollar-yen exchange rate in Tokyo has weakened from around 104 yen per dollar in January 2021 to around 163 in July 2026, a depreciation of more than 50%. The dollar-yen exchange rate last traded around the 160 level in 1986, during Japan's asset-price boom that preceded the country's "lost decades" of weak growth and deflation.

The current weakness is not confined to the dollar alone. Against the British pound, the yen touched a record low of around 219.6 in July, while it has also underperformed the euro, Swiss franc, Australian dollar and New Zealand dollar.

Japanese authorities have repeatedly intervened in the foreign exchange market to stem the currency's slide, but these measures have provided only temporary relief. The persistence of the yen's weakness points to deeper structural forces rather than short-term market speculation.

The yen has long been regarded as one of the world's premier safe-haven currencies, typically strengthening during periods of global uncertainty as investors sought the perceived safety of Japanese assets. That reputation is now under test.

Dollar drift

Despite the Bank of Japan (BoJ) raising its benchmark interest rate to 1% in June—its highest level since the 1990s—the yen has continued to weaken.

The key reason is the persistent interest-rate differential between Japan and the US, which continues to draw capital into higher-yielding dollar assets at the expense of the yen. The US Federal Reserve has kept its policy rate at 3.5-3.75%, while expectations that rates will remain elevated because of persistent inflation have further strengthened the dollar.

The bond market reflects the same divergence. Japan's 10-year government bond yield rose from 0.4% in early 2023 to 2.6% by the second quarter of 2026, but remained well below the US 10-year Treasury yield of 4.4%. The wide yield gap continues to encourage investors to shift funds into higher-return US assets.

It has also sustained the yen carry trade, under which investors borrow cheaply in yen to invest in higher-yielding overseas assets, particularly in the US. The resulting sale of yen and purchase of dollars have kept persistent downward pressure on the Japanese currency despite the BoJ's gradual policy tightening.

Trade troubles

Japan’s dependence on imported energy has emerged as another source of pressure on the yen. Unlike many major economies with sizeable domestic energy supplies, Japan imports nearly all its crude oil and natural gas, leaving its trade balance particularly vulnerable to swings in global energy prices.

Moreover, roughly 90% of Japan’s crude oil imports come from West Asia, with a substantial share passing through the Strait of Hormuz. The recent crisis in West Asia therefore raised Japan’s energy import bill significantly, with the country recording a trade deficit of ¥391.8 billion in May, which widened further to ¥406.9 billion in June.

Since energy imports are largely priced in dollars, the higher import bill increased demand for the US currency, adding to downward pressure on the yen.

Going forward, this could become self-reinforcing: a weaker yen would make dollar-denominated energy imports more expensive, further raising the import bill, widening the trade deficit and, in turn, dragging the yen lower. Prolonged disruptions in West Asia and elevated oil prices could therefore intensify the pressures already weighing on the yen.

Legacy trap

A key reason Japan cannot raise interest rates aggressively to support the yen is that decades of unconventional monetary easing have left the Bank of Japan (BoJ) with an exceptionally large balance sheet.

By December 2025, the BoJ's total assets had reached 102.2% of GDP, compared with 40% for the European Central Bank, 34.4% for the People's Bank of China and 21.6% for the US Federal Reserve.

Over years of large-scale asset purchases, the BoJ has become by far the largest holder of Japanese government bonds. If interest rates were to rise sharply, the market value of its vast holdings of low-yielding bonds would decline, as newly issued bonds would offer higher returns.

Higher rates would also increase the interest the BoJ pays on the enormous reserves held by commercial banks, squeezing its earnings and reducing the surplus it transfers to the government. As a result, aggressive interest-rate hikes to support the yen could trigger financial market volatility while adding to fiscal pressures.

Debt dilemma

Years of fiscal stimulus to support an economy grappling with weak growth and deflation, together with rising social-security spending for a rapidly ageing population, have further complicated the Bank of Japan's task of defending the yen.

In 2024, Japan's general government gross debt stood at 214.5% of GDP, the highest among major advanced economies, compared with 134.7% in Italy, 122.3% in the US and 62.2% in Germany.

The fiscal taps remain open, with Prime Minister Sanae Takaichi's government planning to mobilize more than $2.3 trillion in public and private investment through fiscal 2040 to support long-term growth and economic resilience. This leaves policymakers with little room for aggressive monetary tightening. As interest rates rise, maturing government debt must increasingly be refinanced at higher yields, pushing up debt-servicing costs and placing additional pressure on public finances.

The Bank of Japan, therefore, faces a delicate balancing act between supporting the yen and containing imported inflation, while ensuring that higher interest rates do not undermine fiscal sustainability and destabilise government finances.

Puneet Kumar Arora is an assistant professor of economics at Delhi Technological University. Jaydeep Mukherjee is a professor of economics at Great Lakes Institute of Management, Chennai.

The Japanese yen has fallen to its weakest level in nearly four decades, breaching the 160-per-dollar mark for the first time since 1986. As the world's second most-traded currency pair, sharp dollar-yen movements have far-reaching implications for global trade and financial markets, prompting Japanese authorities—and even the US—to intervene in support of the currency.

While the yen's latest slide reflects a higher energy import bill and the wide US-Japan interest-rate differential, the currency is likely to remain under pressure unless Japan addresses deeper structural challenges, including persistent fiscal expansion and weak long-term growth. Decades of unconventional monetary easing have also constrained Tokyo's ability to raise interest rates aggressively to defend the yen without unsettling financial markets.

Steep slide

Over the past five years, the average dollar-yen exchange rate in Tokyo has weakened from around 104 yen per dollar in January 2021 to around 163 in July 2026, a depreciation of more than 50%. The dollar-yen exchange rate last traded around the 160 level in 1986, during Japan's asset-price boom that preceded the country's "lost decades" of weak growth and deflation.

The current weakness is not confined to the dollar alone. Against the British pound, the yen touched a record low of around 219.6 in July, while it has also underperformed the euro, Swiss franc, Australian dollar and New Zealand dollar.

Japanese authorities have repeatedly intervened in the foreign exchange market to stem the currency's slide, but these measures have provided only temporary relief. The persistence of the yen's weakness points to deeper structural forces rather than short-term market speculation.

The yen has long been regarded as one of the world's premier safe-haven currencies, typically strengthening during periods of global uncertainty as investors sought the perceived safety of Japanese assets. That reputation is now under test.

Dollar drift

Despite the Bank of Japan (BoJ) raising its benchmark interest rate to 1% in June—its highest level since the 1990s—the yen has continued to weaken.

The key reason is the persistent interest-rate differential between Japan and the US, which continues to draw capital into higher-yielding dollar assets at the expense of the yen. The US Federal Reserve has kept its policy rate at 3.5-3.75%, while expectations that rates will remain elevated because of persistent inflation have further strengthened the dollar.

The bond market reflects the same divergence. Japan's 10-year government bond yield rose from 0.4% in early 2023 to 2.6% by the second quarter of 2026, but remained well below the US 10-year Treasury yield of 4.4%. The wide yield gap continues to encourage investors to shift funds into higher-return US assets.

It has also sustained the yen carry trade, under which investors borrow cheaply in yen to invest in higher-yielding overseas assets, particularly in the US. The resulting sale of yen and purchase of dollars have kept persistent downward pressure on the Japanese currency despite the BoJ's gradual policy tightening.

Trade troubles

Japan’s dependence on imported energy has emerged as another source of pressure on the yen. Unlike many major economies with sizeable domestic energy supplies, Japan imports nearly all its crude oil and natural gas, leaving its trade balance particularly vulnerable to swings in global energy prices.

Moreover, roughly 90% of Japan’s crude oil imports come from West Asia, with a substantial share passing through the Strait of Hormuz. The recent crisis in West Asia therefore raised Japan’s energy import bill significantly, with the country recording a trade deficit of ¥391.8 billion in May, which widened further to ¥406.9 billion in June.

Since energy imports are largely priced in dollars, the higher import bill increased demand for the US currency, adding to downward pressure on the yen.

Going forward, this could become self-reinforcing: a weaker yen would make dollar-denominated energy imports more expensive, further raising the import bill, widening the trade deficit and, in turn, dragging the yen lower. Prolonged disruptions in West Asia and elevated oil prices could therefore intensify the pressures already weighing on the yen.

Legacy trap

A key reason Japan cannot raise interest rates aggressively to support the yen is that decades of unconventional monetary easing have left the Bank of Japan (BoJ) with an exceptionally large balance sheet.

By December 2025, the BoJ's total assets had reached 102.2% of GDP, compared with 40% for the European Central Bank, 34.4% for the People's Bank of China and 21.6% for the US Federal Reserve.

Over years of large-scale asset purchases, the BoJ has become by far the largest holder of Japanese government bonds. If interest rates were to rise sharply, the market value of its vast holdings of low-yielding bonds would decline, as newly issued bonds would offer higher returns.

Higher rates would also increase the interest the BoJ pays on the enormous reserves held by commercial banks, squeezing its earnings and reducing the surplus it transfers to the government. As a result, aggressive interest-rate hikes to support the yen could trigger financial market volatility while adding to fiscal pressures.

Debt dilemma

Years of fiscal stimulus to support an economy grappling with weak growth and deflation, together with rising social-security spending for a rapidly ageing population, have further complicated the Bank of Japan's task of defending the yen.

In 2024, Japan's general government gross debt stood at 214.5% of GDP, the highest among major advanced economies, compared with 134.7% in Italy, 122.3% in the US and 62.2% in Germany.

The fiscal taps remain open, with Prime Minister Sanae Takaichi's government planning to mobilize more than $2.3 trillion in public and private investment through fiscal 2040 to support long-term growth and economic resilience. This leaves policymakers with little room for aggressive monetary tightening. As interest rates rise, maturing government debt must increasingly be refinanced at higher yields, pushing up debt-servicing costs and placing additional pressure on public finances.

The Bank of Japan, therefore, faces a delicate balancing act between supporting the yen and containing imported inflation, while ensuring that higher interest rates do not undermine fiscal sustainability and destabilise government finances.

Puneet Kumar Arora is an assistant professor of economics at Delhi Technological University. Jaydeep Mukherjee is a professor of economics at Great Lakes Institute of Management, Chennai.