Behind the yen's continued depreciation even after the Bank of Japan raised rates is a causal relationship that cannot be explained by the interest-rate differential alone. The interest-rate environment in Japan and the US is changing substantially, and market movements are diverging depending on whether rising interest rates reflect monetary policy normalisation or concerns over deteriorating fiscal conditions.
The interest-rate differential between Japan and the US has supported yen depreciation and dollar appreciation, but the Bank of Japan raised its policy rate to 1.25% at its September meeting, while the US Federal Reserve also raised rates by 0.25% during the same period. Both countries therefore remain on a tightening monetary policy path. With many FOMC participants expecting further rate hikes this year, the policy stance is becoming increasingly hawkish. This has led to the view that markets can no longer be explained by the simple interest-rate differential alone.
Market attention is shifting from the "absolute level of the interest-rate differential" to "the reasons behind rising interest rates." Movements in the yen are expected to differ depending on whether higher rates result from monetary policy normalisation or rising long-term interest rates driven by concerns over deteriorating fiscal conditions. The pace of further Bank of Japan rate hikes, Japan's fiscal management and developments in the US have been identified as the key factors that will determine the yen's future direction.