Why the Yen Falls Further the More It Is Rescued: The Answer Lies in Japan’s Own Structural Contradictions

TradingKey - As we enter early 2026, the eyes of global investors are once again locked on the Japanese yen ( JPY ). Despite the Bank of Japan (BoJ) gradually raising policy rates to the 0.5% - 0.75% range, marking a definitive end to the era of negative interest rates, the yen's exchange rate against the U.S. dollar remains on a downward trend.

This anomaly, where even rate hikes cannot save the yen, has stripped away the final veneer of the yen as a "safe-haven asset." It is not merely a matter of interest rate differentials but exposes deep-seated structural contradictions that have accumulated within the Japanese economy over the long term.

The Policy Paradox of "Gas and Brakes" Running Simultaneously

The primary contradiction in Japan's current economic policy stems from a severe misalignment between monetary and fiscal policy.

On the one hand, at the monetary policy level, the Bank of Japan, under the leadership of Kazuo Ueda, is striving to advance "policy normalization." Through rate hikes and quantitative tightening (reducing its balance sheet), the BoJ hopes to curb inflationary pressures stemming from rising import costs and cool down the overheated price system.

Simultaneously, however, fiscal policy is "stepping on the gas." Since taking office, the Sanae Takaichi administration has launched a massive stimulus package worth 21.3 trillion yen to stimulate domestic demand, drive consumption, and solidify voter support, including measures such as cash payouts and tax cuts. While these measures may boost consumption in the short term, they essentially mean the government must take on further debt.

This mismatched policy mix of "monetary tightening + fiscal easing" poses a challenge to market confidence. Observers see a nation whose total debt already exceeds 260% of its Gross Domestic Product (GDP) continuing to sustain its growth path through further debt issuance.

This has raised investor concerns: once the BoJ's rate hike process hits a "ceiling" of fiscal pressure, will it be forced to pause or even pivot?

In short, the policy contradiction of "hiking rates and tightening with one hand while stimulating and spending with the other" not only weakens the yen's international credibility but also causes the market to question Japan's ability to achieve true policy independence and economic sustainability.

The Safe-Haven Status is Collapsing

The yen was long regarded as a safe-haven currency in global financial markets, with capital typically flowing into Japan during periods of volatility. However, by 2026, this traditional logic is undergoing a fundamental shift, and the yen's safe-haven halo is gradually fading.

First, the interest rate differential between Japan and the United States remains wide. Despite the Trump administration signaling strong expectations for rate cuts, the Fed's terminal policy rate is still expected to remain above 3%. In contrast, the BoJ's pace of rate hikes is slow, and overall monetary policy remains relatively accommodative. The narrowing of the spread between the two countries is lagging behind market expectations, keeping the carry trade attractive. Consequently, the yen continues to be used as a low-cost funding currency, facing persistent downward pressure.

Second, investors are reappraising their safe-haven asset allocations. Due to weak Japanese economic fundamentals and a lack of growth momentum, the yen's appeal as a safe-haven asset has declined. An increasing number of institutions are shifting their haven positions to more stable currencies, such as the Swiss franc. During periods of heightened global market volatility, the yen is no longer the preferred choice for risk-averse capital; instead, it faces greater selling pressure during phases of tightening market liquidity.

Furthermore, shifts in the current account balance have further weakened the yen's support. As a nation highly dependent on energy and agricultural imports, Japan has gradually transitioned from a traditional trade surplus country to a long-term trade deficit country. Rather than significantly boosting export competitiveness, the yen's depreciation has exacerbated the burden of import costs, leading to a continuous expansion of the trade deficit. This has created a negative feedback loop of "currency weakness — rising import costs — widening deficit."

Viewed this way, the yen's depreciation is driven not only by monetary policy differences but also reflects the weakening of its safe-haven attributes and the deepening of Japan's structural economic issues.

The "Inflation Pain": Sluggish Wage Growth and Eroding Purchasing Power

For years, the Japanese government has been committed to fostering a virtuous cycle of "wage growth — price increases" to escape the shadow of deflation. However, as of 2026, this idealized path has yet to achieve stable implementation.

The prolonged weakness of the yen has significantly raised the cost of dollar-denominated energy and food imports, driving core CPI to consistently exceed the BoJ's 2% target. This price inflation, driven by exchange rates and external prices, has put pressure on the public's daily lives.

Although large corporations offered relatively positive wage increases during this year's "Shunto" (spring wage negotiations), signaling some recovery on the surface, the impact on the overall labor market has been limited.

The reason is that small and medium-sized enterprises (SMEs), which account for about 70% of Japan's workforce, generally face high costs, low bargaining power, and compressed profit margins, making it difficult for them to raise wages in tandem. As a result, the real wages of most employees have not only failed to grow but have continued to decline as inflation erodes purchasing power.

This situation of "rising nominal wages but declining real purchasing power" is gradually weakening consumer spending power and confidence. Consumers are facing the reality of rising living costs and income growth that cannot keep pace with prices, leading to a contraction in overall domestic demand.

Is "Intervention + Rate Hikes" Required?

Takehiko Nakao, former Vice Minister of Finance for International Affairs and current Chairman of the Institute for International Economic and Strategic Studies, noted that while foreign exchange market intervention can provide a short-term shock to the exchange rate, the BoJ must accompany it with further rate hikes to achieve a more lasting effect.

"Using hard cash to intervene in the market can indeed have a powerful immediate impact, but if the BoJ can demonstrate a clear intention for sustained rate hikes, the effect will be far more profound," Nakao stated.

Currently, the BoJ raised short-term policy rates to 0.75% last December and has signaled possible further tightening ahead. However, against a backdrop of inflation remaining above the 2% target for nearly four consecutive years, Japan's real interest rates remain deep in negative territory. This interest rate structure is one of the fundamental reasons for the long-term pressure on the yen.

Nakao believes that the BoJ remains relatively accommodative, leading markets to expect its tightening pace to be far slower than that of the Fed and other major central banks. Since the interest rate differential between Japan and the U.S. remains significant, capital continues to flow out of Japan, causing the yen to depreciate. He further pointed out: "Responding to inflation through more proactive rate hikes would not only help stabilize the exchange rate but could also curb the excessive rise in long-term government bond yields."

He warned that if the BoJ is slow to tighten policy, the yen could continue to weaken. This would not only trigger market volatility but could also have a greater impact on the public's real purchasing power and import costs.

Nakao also mentioned that the policy leanings of Kevin Warsh, the nominee for the next Fed Chair, will also influence the yen's trajectory. "Warsh is likely to continue the policy philosophy held since former Treasury Secretary Robert Rubin, that a 'strong dollar is in the interest of the United States.' If the U.S. maintains a strong dollar policy while the BoJ delays tightening, the pressure for yen depreciation will likely be even harder to alleviate."