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. Since 2025, as the U.S. cuts rates and Japan raises rates, the policy interest rate gap between Japan and the U.S. has narrowed to its lowest level in about three years, yet the yen remains around 155 yen per dollar, roughly unchanged from 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 interest rates. Market forecasts suggest a 95% probability of a rate hike at the December meeting.

The U.S. Federal Reserve (Fed) decided to cut rates three consecutive times at the 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 in about two and a half years. Generally, an increase in Japanese rates and a decrease in U.S. rates lead to a narrowing of the interest rate gap, which tends to cause the yen to appreciate against the dollar.

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Japan Economic News and the Financial Times merged in November 2015 to form a single media group. The alliance between the two newspapers, founded in the 19th century in Japan and the UK, is under the banner of “high-quality, most powerful economic journalism,” promoting collaboration across a wide range of fields, including special features. As part of this effort, articles are exchanged between the two newspapers’ Chinese-language websites.