- The yen's real effective exchange rate has fallen to its lowest level since the floating exchange rate system was implemented in 1973, sparking widespread discussion in global financial markets about Japan's structural decline in external purchasing power.
- Geopolitical risks in the Middle East have led to international crude oil prices remaining high, and the surge in commodity import costs may cause Japan's international trade balance to deteriorate again in 2026, facing an annual deficit pressure of 5 trillion yen.
- The Suga Cabinet plans to draft a supplementary budget exceeding 3 trillion yen. This expansionary fiscal policy, in the context of relatively loose monetary policy, may further erode market confidence in yen assets.
Real Effective Exchange Rate Hits Historic Low
According to the latest data released by the Bank for International Settlements, the yen's real effective exchange rate, with 2020 as the base period, hit its lowest point on record in April. This indicator, which comprehensively considers inflation rates and trade-weighted weights, confirms the severe loss of the yen's real purchasing power. Although there is debate in the market about the academic view that the yen has become the weakest currency globally due to calculation methods, the yen's weak performance among major developed economies' currencies is a foregone conclusion. If not for the decisive large-scale foreign exchange intervention measures initiated by Japan's Ministry of Finance and the Bank of Japan (BOJ) in late April, the yen-dollar exchange rate might have reached even lower levels under interest rate pressure.
High Energy Prices Force Trade Surplus Reversal
Japan's external trade environment is marginally deteriorating. Although Japan achieved a rare consecutive three-month trade surplus from February to April 2026, this downward cycle repair trend is facing severe tests from the Middle East situation. With three months having passed since the US-Israel attack on Iran, geopolitical premiums have kept international oil prices high, significantly increasing Japan's import payment pressure as a resource-scarce economy. Analysts predict that if the high oil price environment persists in the first half of the year, Japan's annual trade deficit could expand again to around 5 trillion yen, fundamentally cutting off the yen's exchange rate self-repair path.
Potential Conflict Between Active Fiscal and Loose Monetary Policies
In addition to external shocks, Japan's internal policy mix also puts pressure on the yen's exchange rate. To alleviate the impact of high energy costs on microeconomic entities, Prime Minister Suga has clearly stated plans to draft a supplementary budget exceeding 3 trillion yen for the 2026 fiscal year. Within the macro policy framework, if the Bank of Japan maintains a dovish monetary environment while the fiscal side continues to pursue expansionary policies, the dual expansion effect may weaken international investors' confidence in yen sovereign credit. Market pricing shows that long-term government bond yields face upward pressure, reflecting to some extent the market's defensive pricing against the risk of selling Japanese assets.
Structural Turnaround Depends on Potential Growth Rate and Inflation Expectations
In the medium to long term, the fundamental way to reverse the decline in yen purchasing power is to increase Japan's potential economic growth rate. The market is currently closely watching whether the growth-oriented investments proposed by the Suga Cabinet can be substantively implemented and attract foreign capital inflows. Currently, the expected inflation rate reflecting the market's long-term price outlook has successfully broken through the critical 2% level. If this indicator can remain stable, it will guide companies to form long-term wage growth expectations. Once a virtuous cycle of wage increases transmitting to the service industry and consumption is fully established, the structural depreciation pressure on the yen may fundamentally reverse. However, in the short term, businesses and households still need to endure the transitional pain of low purchasing power.
