4th September 2026
Most people probably do not think about the Japanese yen very often.
Unless they are planning a holiday to Japan, buying a Japanese car or watching financial news, the exchange rate between the yen and the pound can seem about as relevant to everyday life in Britain as the weather in Tokyo.
But the yen is telling us something important about the world economy.
For years it has been one of the world's weakest major currencies, driven down by Japan's extraordinarily low interest rates and the huge gap between the returns available in Japan and those available in countries such as the United States.
Now something rather interesting is happening.
After falling to a four-decade low against the US dollar, the yen has suddenly strengthened by more than 2% in a week. Investors are increasingly betting that the Bank of Japan will raise interest rates, while some investors are unwinding the huge trades that involved borrowing cheaply in yen and investing the money elsewhere. Japanese officials are also warning that they remain prepared to intervene if the currency becomes excessively weak.
It might sound like a story about Japan.
It isn't.
It is a story about how modern currencies work, where money flows around the world and ultimately why movements in foreign exchange rates can affect the price of things we buy in Britain.
A currency is a price
One of the easiest mistakes to make when looking at exchange rates is to think of a currency as being either "good" or "bad".
Currencies don't really work like that.
An exchange rate is simply the price of one currency expressed in another.
If £1 buys more dollars, sterling has strengthened against the dollar.
If £1 buys fewer dollars, sterling has weakened.
The same applies to the yen, euro, Swiss franc or any other currency.
But what determines that price?
Interest rates are one of the most important factors.
Investors generally prefer to put their money where they believe they can obtain the best combination of return and safety.
For many years Japan offered something extraordinary by modern standards.
Interest rates were extremely low, sometimes effectively zero.
Meanwhile, the United States offered considerably higher returns.
That created a powerful incentive for investors to borrow in yen, where money was cheap, and invest it in assets offering higher returns elsewhere.
This became known as the yen carry trade.
And when billions, or potentially trillions, of pounds and dollars are involved, the effect on a currency can be enormous.
Japan's unusual experiment
Japan's economic history explains much of this.
After the bursting of its enormous property and share-market bubble in the early 1990s, Japan struggled with weak growth and periods of falling prices.
The Bank of Japan responded with extraordinarily loose monetary policy.
Interest rates were pushed down and kept down for years.
Japan became almost the opposite of the United States during periods when American interest rates were rising.
That created a world in which investors could borrow Japanese money very cheaply.
The yen effectively became a source of cheap funding for the global financial system.
But there was a price.
A weak yen makes imported goods more expensive.
That matters enormously to Japan because it imports large quantities of energy, food and raw materials.
When the yen falls, Japan needs more yen to buy the same quantity of oil priced in dollars, for example.
The result is that a currency crisis can eventually become an inflation problem.
That is one reason Japanese policymakers are now increasingly uncomfortable with excessive yen weakness.
The yen is now sending a different signal
The remarkable thing about the current situation is that the direction may be beginning to change.
The Bank of Japan has gradually moved away from the ultra-low interest-rate policies that characterised Japan for decades.
Its policy rate is now around 1%, and markets are increasingly expecting another increase at its September meeting.
At the same time, Japanese government bond yields have risen sharply, making domestic investments more attractive to Japanese investors.
That changes the calculation.
If you can obtain a better return by keeping money in Japan, there is less reason to send it overseas.
And if the Bank of Japan raises interest rates while the Federal Reserve becomes less inclined to raise American rates, the gap between the two countries becomes smaller.
That can encourage investors to buy yen.
The result can be a surprisingly rapid currency movement.
Indeed, Reuters reports that speculative short positions in the yen are estimated at around ¥17 trillion. If those positions were substantially unwound, the yen could strengthen considerably further.
This is why the yen is worth watching.
It isn't simply telling us about Japan.
It is telling us about the enormous amounts of money moving around the international financial system.
And this is where the pound comes in
Britain has a very different problem.
The pound is not being held down by decades of near-zero Japanese interest rates.
But sterling is still affected by the same forces.
The value of the pound depends partly on what investors think Britain offers compared with other countries.
That includes interest rates, economic growth, government finances, political stability and expectations about future policy.
If investors believe that Britain offers an attractive combination of return and stability, sterling can strengthen.
If they become less enthusiastic about Britain, sterling can weaken.
And unlike the Japanese yen, Britain cannot simply assume that investors will always want to hold sterling.
This matters because Britain imports an enormous range of goods.
When sterling falls against the dollar, things priced internationally in dollars become more expensive in pounds.
Oil is the obvious example.
So are many commodities, industrial materials, electronic components and other internationally traded goods.
That creates a chain reaction.
A weaker pound can mean higher import costs. Higher import costs can mean higher business costs. Higher business costs can eventually mean higher prices for consumers.
That can then feed back into inflation.
And if inflation remains stubborn, the Bank of England can face pressure to keep interest rates higher for longer.
Suddenly an exchange-rate movement that most people never notice can become relevant to their mortgage.
The oil connection is particularly important
This is where currency movements become especially significant for Britain.
Oil is traded internationally in US dollars.
Suppose the price of oil stays exactly the same in dollars.
If sterling weakens against the dollar, British importers still need more pounds to buy that same barrel of oil.
Now imagine the opposite happens at the same time.
Oil prices rise because of geopolitical tensions.
And sterling weakens against the dollar.
Britain then suffers a double squeeze.
The commodity itself is more expensive and the currency in which Britain buys it is weaker.
That can eventually work its way into petrol, diesel, transport, heating and the prices charged by businesses.
For rural communities, where people often have to travel greater distances and have fewer alternatives to cars, the consequences can be particularly noticeable.
But a weak currency isn't always bad
There is another side to this.
A weaker currency can make a country's exports cheaper for foreign customers.
That can benefit manufacturers and exporters.
A British company selling goods in dollars, for example, may receive more pounds when those dollars are converted back into sterling.
Tourism can also benefit.
Foreign visitors may find Britain cheaper when their own currency buys more pounds.
The same principle works in Japan.
Japanese exporters can benefit from a weak yen because their products become relatively cheaper overseas and their foreign earnings are worth more when converted back into yen.
So there is no simple rule saying that a strong currency is good and a weak currency is bad.
It depends on what a country imports, what it exports and what is happening to inflation and wages at the same time.
The danger comes when weakness becomes persistent
The problem begins when a currency stays weak for a long time and businesses and consumers start building that weakness into their expectations.
Importers raise prices because they expect their costs to remain high.
Businesses negotiate higher prices with suppliers.
Workers demand higher wages to compensate for rising living costs.
Consumers then face higher prices.
The central bank responds by keeping interest rates higher.
Higher interest rates increase borrowing costs.
And the economy can become trapped in a rather unpleasant cycle.
Japan has spent decades trying to escape deflation.
Britain has been dealing with the opposite problem: inflation.
The two countries therefore started from very different positions.
But both demonstrate the enormous influence that currencies have on domestic living standards.
What about the US dollar?
The dollar is in a completely different league.
It remains the world's dominant reserve currency and is at the centre of international trade and finance.
Oil and many other commodities are priced in dollars.
Central banks hold dollars as reserves.
International companies borrow and lend in dollars.
That creates enormous demand for the American currency.
But even the dollar isn't immune to changing sentiment.
If investors become concerned about America's inflation, government borrowing or future economic policies, the dollar can weaken.
And when it does, the effects can be felt around the world.
A weaker dollar can make dollar-priced commodities cheaper for countries using other currencies.
But it can also alter the competitiveness of American exports and change the attractiveness of investments around the world.
The dollar is therefore not simply America's currency.
It is part of the plumbing of the international financial system.
The Swiss franc tells another story
There is an interesting contrast with Switzerland.
The Swiss franc is traditionally regarded as a safe-haven currency.
When investors become nervous about the global economy or financial markets, they often look for currencies and assets perceived as relatively safe.
The franc can therefore strengthen for reasons that have little to do with Switzerland suddenly becoming an economic powerhouse.
This demonstrates something important.
Currencies are influenced not just by economic performance but by confidence.
Money moves towards what investors regard as safe, profitable or attractive.
And it moves away from what they regard as risky.
What does the yen tell us about Britain?
Perhaps the biggest lesson is that exchange rates are really a measure of relative economic confidence and financial conditions.
It isn't enough to ask whether Britain is doing well.
Investors are effectively asking:
Is Britain doing better or worse than the alternatives?
That is why sterling can fall even when the British economy is growing.
If investors believe America offers better returns, money can move towards the dollar.
If European assets become more attractive, money can move towards the euro.
If Japan raises interest rates and investors believe the yen has become undervalued, money can move towards Japan.
The currency market is constantly comparing countries with each other.
And there is a warning for savers and homeowners
Currency movements also tell us something about interest rates.
The yen's recent strengthening is partly based on expectations that the Bank of Japan will raise rates.
That demonstrates a fundamental relationship:
interest rates influence currencies, and currencies influence inflation.
Central banks therefore cannot always look only at what is happening inside their own countries.
The Bank of England has to consider sterling.
The Bank of Japan has to consider the yen.
The Federal Reserve has to consider the dollar.
All three are watching each other, even if they do not formally coordinate their interest-rate decisions.
For British borrowers, this matters because inflation and sterling can influence the Bank of England's room for manoeuvre.
For savers, interest-rate changes affect the return they receive on their money.
For businesses, exchange rates affect the cost of imports and the value of exports.
And for consumers, the consequences eventually appear on shop shelves.
The great unwinding
There is perhaps an even bigger financial story developing behind the yen.
For years investors have been able to borrow cheaply in yen and put the money into investments offering higher returns elsewhere.
If Japanese interest rates rise and other countries' rates fall, that trade becomes less attractive.
Investors may start reversing it.
That means selling investments elsewhere and buying yen to repay the original borrowing.
If enough investors do this at the same time, the yen can rise rapidly.
That can then cause other investors to close similar positions.
The process can feed on itself.
This is why financial markets are watching the yen so closely.
Reuters says the current move has already been associated with the unwinding of yen-funded carry trades and a change in investor sentiment.
It doesn't necessarily mean a financial crisis is coming.
But it does mean that something which has been a feature of global markets for many years may be changing.
Britain's currency needs watching too
The Bank of England itself maintains a trade-weighted sterling exchange-rate index because looking only at the pound against the dollar can give a misleading picture.
Britain trades with many countries, not just America.
The Bank's latest weighting gives the euro area a very substantial influence on the sterling index, while the United States accounts for about 22% of the narrow index.
That is an important point for anyone trying to judge whether sterling is genuinely becoming stronger or weaker.
The pound might rise against the dollar but fall against the euro.
Or it might fall against the dollar while remaining relatively stable against the currencies of Britain's other major trading partners.
There isn't really one single "value" of the pound.
There are many exchange rates.
So is the yen a warning?
Perhaps.
Not necessarily a warning that Japan is about to collapse or that Britain is heading for a currency crisis.
The warning is more subtle.
For years the world became accustomed to extremely cheap Japanese money.
Investors borrowed yen cheaply and invested elsewhere.
Now Japan is moving towards higher interest rates, while expectations about American interest rates are changing.
That means some of the enormous flows of money created by the old system may begin to reverse.
And when large quantities of international money move, currencies can move very quickly.
That can affect shares, bonds, commodities and property as well as foreign exchange.
For ordinary people, the important lesson is much simpler.
Currencies aren't just numbers flashing on financial websites.
They affect the price of imported food.
They affect holidays.
They affect petrol and energy.
They affect the cost of imported machinery and components.
They affect the competitiveness of British businesses.
They influence inflation.
And indirectly, they can influence interest rates.
So the next time you see a headline saying that the yen has risen or the pound has fallen, it is worth looking beyond the currency traders.
There may be something much bigger happening underneath.
The yen has spent years showing us what happens when money is almost free. Its sudden recovery may now be showing us what happens when the world starts charging a little more for it.
And Britain, with its heavy reliance on international trade and imported goods, will not be immune to whatever comes next.