Japan’s structural constraints reinforce the yen’s new normal
Japan’s Ministry of Finance intervened in foreign exchange markets in late April and early May 2025, pushing the exchange rate from around 161 yen (US$1.01) to around 155 yen (US$0.97). The moves were decisive and succeeded in slowing the pace of depreciation. Yet the central issue is not whether intervention can stabilise markets in the short term. Policymakers must grapple with why the currency continues to gravitate toward the 160-yen level — and why it no longer rebounds on its own.
In the past, sharp depreciations were often followed by partial corrections once external pressures eased. But structural constraints mean the yen increasingly weakens quickly but shows limited capacity to recover, even when conditions become less adverse.
The yen’s weakness increasingly reflects Japan’s domestic conditions. One key factor is the country’s heavy dependence on imported energy. Rising oil and gas prices worsen the trade balance and generate inflationary pressures. Since 2022, inflation in Japan has remained largely cost-push, eroding real incomes and weakening consumption.
Cost-push inflation suppresses purchasing power and limits economic momentum. In Japan’s case, this dynamic is further complicated by demographic pressures. A shrinking and aging workforce has led to acute labour shortages, which in turn have pushed nominal wages higher. But this wage growth reflects supply constraints rather than strong demand.
While rising nominal wages are a positive development, they have often lagged behind increases in food and energy prices, leaving many households under sustained pressure. Real income growth remains weak and consumption continues to recover only gradually. Even when external pressures ease, there is little domestic support for a rebound in the yen.
At the same time, corporate behaviour reinforces this pattern. Large firms have been able to rationalise operations and pass on higher costs, benefiting from scale and pricing power. By contrast, many small- and medium-sized enterprises face greater difficulty in adjusting to rising input costs, particularly in energy and imported materials. Investment remains cautious and focused on cost-reducing measures rather than forward-looking expansion or innovation. This limits productivity gains and reduces the economy’s capacity to generate sustained growth. A weaker growth outlook then constrains expectations for higher policy rates.
The Bank of Japan’s policy stance reinforces this pattern. The 28 April decision to maintain the policy rate was widely expected. But Bank of Japan Governor Kazuo Ueda’s communication surrounding the issue was revealing. While some observers pointed to higher inflation projections and increased support for future rate hikes among a minority of board members, his tone was notably cautious.
Compared with earlier remarks emphasising risks associated with yen depreciation, he downplayed its impact on inflation and signalled no urgency to tighten policy. This suggests that the Bank of Japan does not view exchange rate movements alone as sufficient grounds for action.
In practice, the Bank of Japan faces a dilemma between supporting fragile domestic demand and preventing further depreciation of the yen. Raising policy rates could support the currency but would also risk weakening consumption, housing activity and smaller firms. Given the fragility of domestic demand, the Bank has opted for caution.
Meanwhile, the external environment continues to favour a weaker yen. The Federal Reserve has kept US yields elevated by maintaining its policy rate at a relatively high level. The resulting interest rate differential remains wide, sustaining capital outflows and demand for dollar-denominated assets.
A growing share of Japanese firms’ overseas earnings is also being reinvested abroad rather than repatriated into yen. Japanese households have also expanded investment in foreign currency-denominated assets, particularly through overseas investment trusts and the expanded Nippon Individual Savings Account program. These capital flows further reinforce persistent downward pressure on the yen.
Multiple structural constraints influence the yen’s weakness. These include sluggish productivity growth, cautious corporate investment, fiscal uncertainty and weak real income dynamics.
These conditions limit the scope for both monetary tightening and fiscal expansion. Aggressive rate hikes could undermine domestic demand, while large-scale fiscal measures could raise concerns about debt sustainability, raise long-term yields, and put additional downward pressure on the yen. Foreign exchange intervention — although effective in slowing volatility — cannot address these underlying issues.
As a result, levels around 160 yen per US dollar are no longer exceptional. They are increasingly consistent with the structure of Japan’s economy and policy framework. The yen’s depreciation is becoming less a temporary deviation and increasingly a reflection of underlying structural and policy fundamentals.
At the same time, some observers point out that the yen’s current level appears significantly weaker than suggested by long-term purchasing power parity measures. While this is not a reliable guide to short-term exchange rate movements, the scale of the deviation in 2026 may raise questions about whether the market level can be sustained indefinitely.
This does not imply a one-way trajectory or permanent stabilisation. Periods of appreciation remain possible — particularly if global financial conditions shift or US interest rates decline. But such recoveries are likely to be limited without a meaningful strengthening of domestic demand or a clearer path toward policy normalisation.
In this sense, the yen’s market behaviour is less a temporary deviation than an increasingly accurate reflection of the deeper structural constraints within the Japanese economy.
Sayuri Shirai is Professor of Economics at the Faculty of Policy Management, Keio University, Advisor for Sustainable Policies at the Asian Development Bank and a former board member of the Bank of Japan.