After the Japanese government and central bank implemented foreign exchange interventions last month, the Japanese yen gained temporary support. However, according to Nikkei Asia on May 27th, the real exchange rate of the Japanese yen has dropped to its lowest level since the 1970s. Trade deficits and other structural factors contributing to selling pressures have been exacerbated by rising oil prices, further weakening the value of the Japanese yen.
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The real effective exchange rate takes into account factors such as price fluctuations and trade volumes, in order to determine a currencys actual purchasing power relative to other currencies. When a country experiences higher inflation than other countries, its real effective exchange rate generally increases; conversely, it decreases when inflation is lower in other countries.
Importantly, despite persistent high inflation, the Turkish Central Bank has continued to implement loose monetary policies over a long period. This has led to a decline in market confidence in the lira, causing it to remain in a state of depreciation. For this reason, the lira has always been considered one of the weakest currencies in the world.
Importantly, Brooks statement that the real effective exchange rate between the Japanese yen and the Italian lira has inverted in recent times was difficult for Japanese media to accept. Reports claimed that this claim was somewhat exaggerated. The real effective exchange rate reflects the degree of change in the purchasing power of a currency relative to the base year. There are various methods for calculating this value. Even when comparing currencies with the same parameters, the comparability of absolute values between different currencies remains a controversial issue.
However, Nikkei Asia also acknowledges that the real effective exchange rate of the Japanese yen continues to decline, while the lira has shown a trend of recovery recently.
According to data from the Bank for International Settlements, based on 2020 as a reference point, the real effective exchange rate of the Japanese yen dropped to its lowest level since Japan adopted a floating exchange rate system in 1973 in April this year. In contrast, the Turkish lira has recovered by approximately 7% since the beginning of this year.
Yen (blue) and Lira (black) Real Effective Exchange Rates Changes – Brooks Personal Website
The report indicates that high inflation in Turkey over the long term tends to increase the real effective exchange rate. However, even considering this factor, there is still a significant difference in the trends of the Japanese yen and the lira. Currently, there are no signs of a significant rebound for the Japanese yen, and it faces many unfavorable factors.
Importantly, Japans trade deficit surged sharply to 20 trillion yen in 2022 (approximately 849.9 billion yuan). However, the deficit gradually decreased over time, and by 2025, it had dropped to less than 3 trillion yen. Since February 2026, Japan has recorded a monthly trade surplus for three consecutive months.
However, the situation in the Middle East has led to higher oil prices, once again casting a shadow over Japans trade prospects. According to analysis by Kyohei Miyake, a senior economist at SMBC Nikko Securities, the trade deficit is likely to widen once again, reaching around 5 trillion yen per year. This means that the Japanese yen is facing further downward pressure.
Meanwhile, Japans financial situation is also increasing market concerns about the Japanese yen. Due to high energy prices, Japanese Prime Minister Yoshihiko Kuroda has been promoting expansionary fiscal policies. On the 25th, she announced plans to create a supplementary budget for the fiscal year 2026, with a total amount exceeding 3 trillion yen.
Tetsu Takeda, Chief Economist at Itochi Corporations Research Institute, stated that maintaining a loose monetary environment while implementing proactive fiscal policies will erode market confidence in the Japanese yen. This is leading to a wave of selling off Japan, including an increase in interest rates.
There is also growing speculation in the market that the Japanese central bank is lagging behind other central banks in its decision to raise interest rates. Given the huge debt burden of the Japanese government, it is difficult for the Japanese central bank to raise interest rates quickly. This would significantly increase the interest costs on government bonds and exacerbate fiscal pressures. Analysts believe that the interest rate differential between the United States and Japan is significant, and Japans economic structure remains trapped in a situation where low interest rates and low growth are the norm.
Theoretically, a depreciation of the Japanese yen could help enhance export competitiveness, thereby boosting Japans economy by increasing export volumes. However, since many Japanese companies have already moved their production bases overseas, the positive impact of a yen depreciation on the economy is now significantly weaker than in the past.
Since the United States and Israel launched their war against Iran three months ago, there has been a significant divergence in the trends of major global currencies relative to the US dollar. Countries with energy self-sufficiency have generally seen their currencies appreciate. Meanwhile, Latin American countries, which are less affected by geopolitical risks in the Middle East, have also shown strong performance. In contrast, the Indonesian rupiah, the Korean won, and the Turkish lira have experienced significant declines, with losses ranging between 4% and 5%.
In comparison, the yens decline against the US dollar was slightly less than 2% during the same period. This seems relatively limited on the surface. However, the market generally believes that since late April, the Japanese government and the Bank of Japan have implemented measures involving approximately 10 trillion yen in buying interventions. Therefore, the current exchange rate can be considered as being manually supported to some extent. Without such interventions, the yen could weaken further.
Analysis suggests that to truly prevent the long-term depreciation of the Japanese yen, Japan needs to expand domestic demand through growth strategies and increase its potential economic growth rate. Takeda Jun said that the key lies in whether local governments can rely on growth strategy investments to promote the development of local industries and attract foreign capital inflows.
Mitsubishi Research Institutes chief economist, Toshiharu Higashizawa, focused his attention on changes in Japans expected inflation rate. He pointed out that Japans current expected inflation rate has exceeded 2%. If this level can be maintained, companies may become more proactive in raising wages to cope with the ongoing inflation expectations. As wage increases gradually affect service prices, a cycle of inflation in Japans real economy could emerge. Additionally, the decline in the real purchasing power of the Japanese yen is expected to stabilize.
However, Tohei Shimizu also warned that it often takes several years for inflation expectations to translate into actual inflation. Therefore, it is unlikely that the purchasing power of the Japanese yen will increase in the short term.
