The mystery of the yen's continued depreciation despite narrowing interest rate gap between Japan and the US

The conclusion that “the narrowing of interest rate differentials leads to yen appreciation” in the foreign exchange market has become invalid. Since 2025, the U.S. has cut interest rates while Japan has raised them, narrowing the policy interest rate differential between the U.S. and Japan to its lowest level in about three years. However, the yen exchange rate remains around 155 yen to 1 dollar, basically unchanged from the beginning of the year. Where is the key to understanding this “puzzle” of the yen’s continued depreciation despite the narrowing interest rate differential?

The Bank of Japan will hold a monetary policy meeting on December 18-19 to discuss raising policy interest rates. The market predicts a 95% probability of a rate hike at the December meeting.

The U.S. Federal Reserve’s decision during the FOMC meeting in December to cut rates three times consecutively will result in the U.S.-Japan policy interest rate differential dropping to its lowest level in about three years if the Bank of Japan decides to raise rates. Currently, the actual interest rate differential has narrowed to its lowest level in about two and a half years. Generally speaking, an increase in Japanese interest rates and a decrease in U.S. interest rates leading to a narrowing of the interest rate differential will result in the yen appreciating against the dollar.

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The Nihon Keizai Shimbun and the Financial Times merged to form the same media group in November 2015. An alliance formed by two newspapers from Japan and the UK, both founded in the 19th century, is promoting extensive collaboration in various fields under the banner of “high-quality, the most powerful economic journalism.” As part of this, articles will be exchanged between the Chinese websites of the two newspapers.