For more than three decades, Japan followed one of the most unusual economic experiments in the world. While most countries worried about prices rising too fast, Japan struggled with the opposite problem: very low inflation and, at times, falling prices.
To fight this, the Bank of Japan (BOJ) kept interest rates extremely low, bought huge amounts of government bonds and eventually introduced negative interest rates. These policies were meant to revive Japan’s economy. But they also made the Japanese yen one of the cheapest major currencies to borrow, helping create what we now call the yen carry trade.
It Started With Japan’s Great Bubble
During the 1980s, Japan was booming. Property prices and share prices rose dramatically, and Japanese companies were expanding around the world. The Nikkei 225 reached a record closing level of 38,915.87 in December 1989.
Then the bubble burst. Property and share prices collapsed, banks were left with bad loans, and economic growth slowed sharply. Japan then entered what became known as its “Lost Decades.” One of its biggest problems was deflation.
Why Deflation Was Such a Problem
Deflation simply means that prices generally fall instead of rise. Falling prices may sound good, but if people expect things to become cheaper next year, they may postpone purchases.
Businesses then sell less, invest less and become reluctant to increase wages. Consumers become even more careful with money. This can create a cycle of weak spending, weak growth and falling prices. The BOJ therefore wanted people and businesses to spend and invest more.
Japan Pushes Interest Rates Down
The BOJ gradually reduced interest rates until they were close to zero. But once rates are already near zero, there is very little room to cut them further.
So in 2001, the BOJ introduced quantitative easing, or QE. Instead of depending only on interest-rate cuts, it began supplying much more money to the financial system, including through purchases of Japanese government bonds.
When the BOJ bought bonds from banks and other investors, it paid for them with central-bank money. This increased the amount of money available in the financial system.
Why Did the BOJ Buy Bonds?
The bond purchases also increased demand for government bonds. When demand for a bond rises, its price generally rises, and when its price rises, its yield falls.
For example, imagine a bond costing ¥100 and paying ¥2 a year. Its yield is 2%. If strong demand pushes its price to ¥110 while the payment remains ¥2, the yield falls to about 1.8%.
Government bond yields influence many other interest rates. So lower government bond yields can eventually mean cheaper loans for companies and households.
The idea was simple: make borrowing cheap and money easily available. The BOJ hoped banks would lend more, businesses would invest more and consumers would spend more. Stronger demand would then help Japan escape deflation.
2013: Japan Goes Much Further
In 2013, the BOJ launched a much bigger programme called Quantitative and Qualitative Monetary Easing, or QQE. The BOJ planned to increase Japan’s monetary base by around ¥60–70 trillion per year. It also dramatically increased its purchases of government bonds and bought other assets such as exchange-traded funds, or ETFs.
The goal was to bring inflation to around 2%. Japan was now deliberately creating an environment in which money would remain extremely cheap.
Then Came Negative Interest Rates
In 2016, Japan went even further. The BOJ introduced a −0.1% interest rate on part of the balances that financial institutions kept with it. This did not mean ordinary Japanese depositors were automatically charged −0.1%. It mainly applied to part of the money financial institutions held at the BOJ.
Later that year, the BOJ introduced Yield Curve Control, or YCC. It aimed to keep the yield on the 10-year Japanese government bond at around 0%. Japan had effectively created extremely cheap borrowing conditions for a very long period.
And this is where the yen carry trade becomes important.
What Is the Yen Carry Trade?
The idea is surprisingly simple. Suppose you can borrow money in Japan at 1% and invest it somewhere else for 5%. In theory, the difference is about 4 percentage points.
An investor could therefore borrow yen, convert the yen into dollars and use those dollars to buy higher-returning assets in the United States or elsewhere.
The money did not have to go into a bank deposit. Investors could buy government bonds, corporate bonds, shares and other financial assets. Because Japanese interest rates remained so low for so long, the yen became an important funding currency for investors around the world.
But There Is a Big Risk
The carry trade works well when Japanese interest rates remain low and the yen remains weak or relatively stable.
Imagine an investor borrows ¥150 million when $1 equals ¥150. That gives the investor about $1 million to invest. But suppose the yen later strengthens to ¥120 per dollar. The investor would then need $1.25 million to buy the ¥150 million required to repay the original loan.
The currency loss could easily wipe out the extra investment return. This is the hidden danger of the yen carry trade.
Why This Can Affect Stock Markets
When the yen is cheap and stable, investors may borrow more yen and put that money into higher-returning assets around the world. Some of this money can flow into stock markets.
But the process can suddenly reverse. If Japanese interest rates rise or the yen strengthens sharply, investors may decide to close their carry trades. They sell foreign shares, bonds and other investments and buy yen to repay their Japanese borrowing.
If many investors do this together, the selling can become powerful. That is why changes in Japanese interest rates can sometimes affect American, European and emerging-market stock markets, not just Japan.
Japan’s Own Stock Market Had a Very Different Story
Interestingly, decades of cheap money did not immediately restore Japan’s own stock market. After reaching 38,915.87 in December 1989, the Nikkei remained below that closing record for more than 34 years.
It finally broke the old record in February 2024, closing at 39,098.68. This shows an important point: low interest rates can support asset prices, but cheap money alone cannot guarantee a strong stock market or economy.
Why Did Japan Finally Decide to Change Direction?
For years, the BOJ kept interest rates extremely low because Japan’s main problem was weak inflation and deflation. But after the pandemic, the situation began to change. Prices started rising more strongly, partly because energy, food and other imported goods became more expensive.
At first, the BOJ was cautious. It did not want to raise interest rates simply because imported goods had become expensive. What it really wanted to see was prices rising together with wages. If workers earned more, they could spend more. Stronger consumer spending could allow businesses to raise prices and, in turn, pay higher wages.
By 2023 and early 2024, there were signs that this was finally beginning to happen. Corporate profits were relatively strong, the labour market was tight, and Japanese companies were giving workers larger pay increases. The results of Japan’s important spring wage negotiations in 2024 gave the BOJ further confidence that wage growth was becoming stronger.
This was important because the BOJ had spent years trying to create exactly this kind of cycle between wages, spending and prices. The central bank believed that its 2% inflation target was finally within sight on a sustainable basis, rather than inflation being caused mainly by temporary increases in imported costs.
In simple terms, Japan’s problem was changing. For decades, the danger had been that prices and wages would hardly rise at all. Now wages and prices were beginning to rise together. Keeping emergency-level policies such as negative interest rates forever was therefore becoming less necessary.
That gave the BOJ the confidence to slowly begin bringing monetary policy back towards normal.
2024: Japan Finally Changes Direction
In March 2024, the BOJ ended its negative-interest-rate policy. It moved its short-term rate from −0.1% to around 0%–0.1% and also ended Yield Curve Control.
Then, in July 2024, it raised the policy rate to around 0.25%. That sounds like a tiny interest rate. But for investors who had become accustomed to almost free Japanese money, the direction of change mattered.
Around the same time, the yen strengthened and investors began unwinding some carry trades. On August 5, 2024, Japan’s Nikkei fell 12.4% in a single day, its biggest percentage fall since the 1987 Black Monday crash. Global markets were also under heavy pressure.
The carry-trade unwind was not the only reason for the fall—concerns about the U.S. economy and other factors also mattered—but it demonstrated how changes in Japan could quickly spread through global financial markets.
Japan Is Slowly Leaving the Zero-Rate Era
The BOJ continued raising rates. It increased the policy rate to around 0.5% in January 2025, then to 0.75% in December 2025 and finally to 1.0% in June 2026. At its July 2026 meeting, the BOJ kept the rate unchanged at 1.0%.
That gives us a remarkable progression: −0.1% in 2016, 0–0.1% in March 2024, 0.25% in July 2024, 0.5% in January 2025, 0.75% in December 2025 and 1.0% in June 2026.
Even 1.0% is still relatively low compared with interest rates in several other major economies. But for Japan, which spent years with rates around zero or below zero, the change is significant.
Japan Is Also Intervening to Support the Yen
Even after these rate increases, the yen remained very weak in 2026. At one point it fell to around ¥164 per U.S. dollar, close to its weakest level in decades.
Japan responded with large-scale currency intervention. Between July 30 and August 26, 2026, Japan spent about ¥15.4 trillion buying yen in the foreign-exchange market in an effort to support the currency.
It is important to understand that this intervention is different from the BOJ raising interest rates. Foreign-exchange intervention is decided by Japan’s Ministry of Finance, while the Bank of Japan carries out the transactions as its agent.
Japan also carried out a coordinated yen-buying intervention with the United States on July 31, 2026. The aim was to control excessive and disorderly movements in the currency.
This shows how important the yen has become. Japan is now slowly raising interest rates while also trying to prevent excessive weakness in its currency.
Why the Carry Trade Still Matters
The most important thing is not simply Japan’s interest rate. It is the difference between Japanese rates and rates elsewhere.
If an investor can borrow yen at 1.0% and earn 4% or 5% elsewhere, there may still be an attraction. But if Japanese rates rise while U.S. or European rates fall, that gap becomes smaller. A stronger yen makes the trade even less attractive.
That is why investors now closely watch both the Bank of Japan and the U.S. Federal Reserve.
The Bigger Lesson
Japan did not create cheap money to boost American or global stock markets. It was trying to solve its own problems of weak growth and deflation.
But money does not necessarily stay in the country where it is borrowed. Cheap yen could be borrowed in Tokyo, converted into dollars and invested in American stocks, bonds or assets elsewhere in the world.
For decades, investors became comfortable with one assumption: Japanese money would remain extremely cheap. That assumption is now being tested.
And that is what makes the yen carry trade so important. Cheap money created in one country can travel around the world. And when that money becomes less cheap, markets around the world can feel the effect.
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