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, the U.S. has cut interest rates while Japan has raised them, reducing the policy rate gap to its lowest level in about three years. However, the yen remains around 155 yen per dollar, roughly unchanged since 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 interest rates three consecutive times at the December meeting of the Federal Open Market Committee (FOMC). If the Bank of Japan decides to raise rates, the policy rate gap between Japan and the U.S. will shrink to its smallest level in about three years. Currently, the actual interest rate differential has narrowed to its lowest point in about two and a half years. Generally, rising Japanese interest rates and falling U.S. interest rates lead to a narrowing of the interest rate differential, 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 the same media group. The alliance between the two newspapers, founded in the 19th century in Japan and the UK, is committed to “high-quality, comprehensive economic news,” promoting collaboration across various fields such as special reports. As part of this effort, articles are exchanged between the two newspapers’ Chinese-language websites.