The Japanese yen is one of the most sensitive currencies in the Forex market, and interest rate changes play a major role in its movement. For years, low Japanese rates encouraged carry trades, where investors borrowed in yen and invested in higher yielding currencies. This kept the yen relatively weak.
With the Bank of Japan raising rates, that dynamic begins to change. Even a modest increase can affect expectations, reducing the appeal of borrowing in yen and encouraging some capital to return to Japan. As a result, the yen can strengthen, especially against currencies where rate advantages may narrow.
This shift has direct implications for major Forex pairs such as USD/JPY and EUR/JPY. When markets believe Japanese policy is becoming less accommodative, volatility often increases as traders adjust long held positions.
However, the impact is not one directional. Much depends on how quickly and how far Japan continues to tighten policy, especially compared with other central banks. This makes the yen a key currency to watch as global interest rate paths begin to diverge.
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