Japan's long-term economic weakness has dragged down the yen's overall strength, with the real effective exchange rate index reflecting the currency's purchasing power falling to its lowest level in 53 years. According to a report on the 21st, the yen's composite exchange rate against major currencies dropped last month to its lowest point since 1971, shrinking by approximately two-thirds compared to its peak in April 1995. Data released on the 20th by the Bank for International Settlements showed that as of January this year, the yen's real effective exchange rate index stood at 67.73, the lowest since records began in 1973.

The real effective exchange rate index measures the yen's comprehensive strength against a basket of major currencies and reflects its actual purchasing power when buying foreign goods. A decline in the index indicates a corresponding weakening of purchasing power. This indicator had previously reached a historical high of 193.95 in April 1995 but has since fallen to about one-third of that level.

Despite the Bank of Japan raising interest rates from negative 0.1% to 0.75% over the past two years—a move that should theoretically attract yield-seeking capital inflows and strengthen the yen—the currency's performance remains weak, nearly matching its 38-year low hit in mid-2024. A researcher from the Brookings Institution noted that, when calculated on a trade-weighted basis and adjusted for inflation, the yen remains one of the world's weakest currencies.

A key factor behind this situation is Japan's prolonged economic stagnation following the collapse of its bubble economy. Data from the Bank of Japan indicate that the country's potential growth rate was around 1% in 1995 but had fallen to nearly 0% by the end of the 2010s. Weak growth potential has led to long-term low inflation and interest rates, contributing to the sustained decline in the real effective exchange rate. Recently, as prices and wages have risen in tandem, the Bank of Japan has been working to normalize monetary policy. The central bank has indicated plans to further raise policy rates from the current level of 0.75%. However, a critical question remains: Can households and businesses withstand the impact of interest rate hikes?

According to estimates by Mizuho Research & Technologies, a single 0.25 percentage point increase in the policy rate would add approximately 18,000 yen per year to the repayment burden for households carrying debts such as mortgages. For businesses, excluding the financial and insurance sectors, a single rate hike would reduce average operating profits by 0.9%.

Japan's policy rate is now at its highest level in 30 years. As more analysts expect the Bank of Japan to continue raising rates to a range of 1.5% to 1.75%, risks to the Japanese economy may further increase.

Prime Minister Sanae Takaichi has pledged to prioritize domestic investment. However, the chief investment officer of UBS SuMi TRUST Wealth Management noted that, despite the weak yen, corporate investment in Japan remains slow due to market skepticism about growth potential.

Prime Minister Takaichi previously stated that yen depreciation could boost domestic investment and make Japanese-made goods more competitive for export. Finance Minister Satsuki Katayama, however, described the Prime Minister's explanation as "textbook" rhetoric. In recent years, developments have not followed the "textbook" path. A 2024 government-commissioned report by economists concluded that the fundamental reason for sluggish domestic corporate investment in Japan is the widespread perception among businesses that returns on domestic investment are low.