Why is the yen depreciating despite rising long-term interest rates?

Japanese long-term interest rates have been rising rapidly, yet the yen has continued to depreciate. The nominal interest rate underlying long-term rates is the real interest rate plus expected inflation, and the BEI has risen sharply since the beginning of this year, exceeding 2.2%. The rise in the BEI is contributing to higher long-term interest rates.

The rise in long-term interest rates is also linked to higher short-term interest rates. As the Bank of Japan normalizes monetary policy and reduces its purchases of government bonds through quantitative tightening (QT), there is a shift in the supply and demand for government bonds toward the private sector. This makes long-term interest rates more likely to rise.

Fiscal risk is reflected in the widening spread between short- and long-term interest rates. Japan’s interest-rate spread is unusually wide and is said to have widened after the change in government to Prime Minister Takaichi (高市) in October 2025. Expanding fiscal deficits and increased government bond issuance are regarded as factors that raise the yields investors demand.

Rising overseas interest rates are also cited as a factor affecting yen depreciation. Investors compare bonds globally, and the greater the presence of overseas investors in the Japanese government bond market, the more likely Japan’s fiscal and monetary policies are to be reflected in interest rates through international assessments of them.

An analysis breaking down the factors including fiscal risk and inflation indicates that, excluding short-term interest rates, fiscal factors could be the largest contributor. It also explains that household deposits of ¥1,100 trillion are not synonymous with the ¥575 trillion monetary base, which fluctuates under the influence of the Bank of Japan’s monetary policy.