Yen Slumps to G10 Bottom Amid BOJ Hikes, Fiscal Expansion Risks

Japan's yen continued to weaken in 2025 despite the Bank of Japan (BOJ) raising interest rates for the third time this year. The currency was the worst-performing G10 currency against the U.S. dollar, raising concerns about potential government intervention. Prime Minister Sanae Takaichi's government signaled fiscal discipline in the upcoming fiscal year, but market pressures remain high as inflation and wage growth persist according to market analysis.

The BOJ increased its policy rate to a 30-year high of 0.75% on December 19, 2025, as it signaled further tightening to meet its 2% inflation target. Governor Kazuo Ueda emphasized that the economy is moving closer to sustained inflation and warned of the risks of returning to deflationary trends. The central bank remains cautious, however, as it balances inflation control with the need to avoid destabilizing the yen.

With the BOJ expected to raise rates further in 2026, investors are closely watching for signs of how quickly the central bank will normalize monetary policy. Market participants have already priced in more than 40 basis points of additional hikes next year according to market forecasts. However, the yen has struggled to stabilize, remaining in a "danger zone" where intervention could still be triggered.

Why the Yen Remains Under Pressure

The yen's weakness is driven by a combination of domestic and global factors. Japan's fiscal and monetary policies, while aiming to stimulate the economy, have also raised inflation and pushed up import costs. Meanwhile, the U.S. Federal Reserve is expected to remain on a tighter policy path compared to most G10 central banks, keeping the dollar strong. This has limited the yen's ability to rebound despite the BOJ's rate hikes.

Governor Ueda has signaled that further tightening could help Japan achieve its inflation target, but the central bank remains cautious. He emphasized that policy adjustments must be made at an "appropriate pace" to avoid disrupting the fragile economic recovery. At the same time, the BOJ must also manage expectations from investors and the government, both of which are closely monitoring the central bank's actions.

Risks to the Outlook

Japan's government is under pressure to balance economic growth with fiscal sustainability. Prime Minister Takaichi announced a record ¥122.3 trillion budget for fiscal 2026, which includes a significant expansionary spending package. While the government aims to support households and businesses amid rising costs, this approach could backfire by fueling inflation and weakening the yen according to financial analysts.

The yen's weakness has already become a concern for policymakers, with Finance Minister Satsuki Katayama warning of potential intervention if the currency moves excessively against the dollar. The BOJ's recent rate hike failed to stabilize the yen, and further declines could prompt Tokyo to take action according to market reports.

Another risk is the potential for rising bond yields as Japan increases its reliance on debt financing. The Finance Ministry plans to raise the provisional interest rate for calculating debt servicing costs to 3%, the highest since 1997. This could increase borrowing costs for the government and push yields higher, further pressuring the yen.

What This Means for Investors

For investors, the BOJ's tightening path and Japan's fiscal policies present both opportunities and risks. Rising interest rates could make Japanese government bonds more attractive, but they also raise the likelihood of market volatility. The yen's weakness has already pushed up inflation and import costs, which could affect consumption and corporate profits.

Analysts are also watching for signs of coordination between the BOJ and the government. While Ueda has signaled a cautious approach to rate hikes, the government's push for reflationary policies could create tension. If the BOJ moves too slowly, it risks losing control over inflation and currency stability. If it moves too quickly, it could disrupt the fragile economic recovery according to market analysis.

In the short term, the yen is likely to remain volatile as the BOJ and government navigate these challenges. Investors will be closely watching for further guidance from Ueda and any signs of intervention from Tokyo. The coming months will test Japan's ability to balance monetary tightening with fiscal stimulus without destabilizing its currency.