After the dollar-yen exchange rate fell to the ¥164 range, it returned to around ¥159, while the market has been signaling a September rate hike by the Bank of Japan. Some have also pointed out that the yen's depreciation cannot be explained by the Japan-US interest-rate differential alone, and the factors behind the yen's prolonged weakness are being discussed.
After the dollar-yen exchange rate temporarily fell to around ¥164, it returned to the ¥155 range following coordinated intervention by Japan and the United States. The effect did not last long, however, and the yen has now weakened again to around ¥159. The market is increasingly expecting the Bank of Japan to raise rates in September.
The yen is considered exceptionally undervalued relative to fundamentals. Purchasing power parity (PPP) indicates a rate of ¥97 to the dollar, while the Big Mac Index suggests that the yen is undervalued relative to its purchasing power. One factor cited is a mechanism behind the yen's depreciation that cannot be explained by the interest-rate differential alone.
Behind the yen's depreciation is the fact that Japanese companies are converting and bringing back only limited amounts of their overseas earnings into yen, while households and institutional investors are increasing their holdings of overseas assets. Japan's current-account surplus no longer offsets the yen's depreciation through yen purchases alone. Japan has substantial net external assets, and the failure of foreign funds to return to the yen is seen as a factor prolonging its weakness.
The Bank of Japan left its policy rate unchanged at 1.0% at its late-July policy meeting, although some committee members at the meeting proposed an additional rate hike. The BOJ expects inflation to exceed 2% in the latter half of fiscal 2026, and real interest rates are expected to remain negative. Some believe the BOJ is deferring rate hikes for political considerations.