US Treasury Says Yen Is Deeply Undervalued, Urges Bank of Japan to Continue Rate Hikes

Key Takeaways

In its latest foreign exchange report, the US Treasury said the yen remains significantly undervalued and urged the Bank of Japan to continue raising interest rates, arguing that policy normalization would help contain inflation and reduce excessive currency volatility.

The US Treasury has called on the Bank of Japan (BOJ) to continue tightening monetary policy, warning that the Japanese yen remains significantly undervalued despite a narrowing interest rate gap between the United States and Japan.

In its semiannual foreign exchange report released on Thursday, the Treasury said the yen's persistent weakness is undesirable and stressed that further monetary policy normalization could help stabilize inflation expectations while limiting excessive exchange-rate fluctuations.

The report noted that although global factors such as financial market volatility and oil prices have influenced the currency, the yen has continued to weaken even as the US-Japan yield differential has narrowed.

US Treasury Flags Yen as Significantly Undervalued

According to the report, both the yen's real effective exchange rate and its value against the US dollar have fallen by around 51% between the end of 2011 and April 2026, leading the Treasury to conclude that the Japanese currency is substantially undervalued.

The Treasury also highlighted that nominal wages in Japan have risen, but inflation continues to erode household purchasing power, reinforcing the case for additional BOJ rate increases.

US officials said they will continue close consultations with Japan's Ministry of Finance on macroeconomic and foreign exchange issues.

Yen Near 40-Year Low Keeps Intervention Risks in Focus

The US dollar traded close to JPY 164 on Thursday, leaving the yen near its weakest level in four decades.

Japanese authorities have repeatedly warned that they are prepared to intervene if currency movements become excessively volatile. Finance Minister officials reiterated that Tokyo had previously stepped into the market after the dollar rose above the JPY 160 level in April and May, adding that further action remains an option if needed.

Inflation Supports Case for Further BOJ Tightening

Fresh inflation data released on Friday added to expectations that the BOJ could raise interest rates again later this year.

Japan's core consumer price index (excluding fresh food) rose 1.6% year-on-year in June, marking the first acceleration in three months. A measure excluding both fresh food and energy increased 1.7%, while headline inflation also came in at 1.7%.

Although government subsidies have continued to limit energy costs, the pace of price declines slowed, while durable goods and healthcare costs also contributed to stronger inflation.

The figures reinforce the BOJ's inflation outlook following last month's rate increase, which lifted its benchmark interest rate to the highest level since 1995.

Markets Expect July Pause but See More Rate Hikes Ahead

Despite stronger inflation, economists broadly expect the BOJ to leave interest rates unchanged at its July 31 policy meeting as officials assess the impact of previous tightening measures.

However, the central bank's updated quarterly economic forecasts could provide guidance on the timing of future rate increases.

Market expectations for additional tightening have continued to build, with Japan's two-year government bond yield climbing to its highest level in more than three decades.

Recent analyst surveys indicate that many BOJ watchers expect the next rate hike to come in either October or December, although policymakers are expected to remain data-dependent and closely monitor inflation, economic growth, currency movements, and financial market conditions.