Editor's note: Tang Jie is a researcher at the Chinese Academy of International Trade and Economic Cooperation under China's Ministry of Commerce. The article reflects the author's opinions and not necessarily those of CGTN.

Since taking office, Japanese Prime Minister Takaichi Sanae has – under the banner of responsible fiscal activism – implemented large-scale tax cuts in an attempt to stimulate demand and pursue a high-pressure economy.

Going further, the Takaichi government has sought to place politics above economic reality: Under its push, the goal of raising defense spending to 2% of GDP was brought forward to fiscal year 2025, a move that has prompted alarm and diplomatic pushback from neighboring countries and inflicted adverse effects on Japan's economy, public finances and external economic relations.

Yet Japan's economy today is persistently constrained on the supply side by unfavorable demographic trends and chronic labor shortages. Research institutions such as Nomura Research Institute argue that under these conditions, high-pressure demand stimulus cannot expand Japan's supply capacity.

The Bank of Japan (BOJ) is facing pressure from financial markets: Yen depreciation and rising long-term bond yields have forced it to raise the policy rate to 1.25% – the highest in 31 years – in what amounts to a reluctant response to downward pressure on the yen. 

At the same time, the central bank faces pressure from the government. The BOJ's 7–2 vote laid bare its policy dilemma: Two Takaichi-appointed policy board members dissented against the hike, pitting the central bank's fight against yen weakness against the government's push for stimulus, bringing the BOJ’s policy stance into conflict with the government’s easing demands.

Although the BOJ has tried to normalize monetary policy through rate hikes and reduced Japanese government bond purchases (quantitative tightening), the scope and pace of further hikes are severely constrained by Japan's domestic economic structure. 

Japan's general government debt exceeds 250% of GDP. A 100-basis-point rise in interest rates would materially increase the government's future debt-service costs and encroach on the fiscal space available for other spending. A sharp increase in the policy rate could trigger concerns over fiscal sustainability and, in turn, undermine sovereign creditworthiness.Yet, standing pat is not a feasible alternative: A failure to hike would let the yen slide further and import still more inflation.

Japan's heavy dependence on imported energy means yen depreciation translates almost directly into higher prices. Moreover, recent inflation has been driven mainly by rising import prices for energy and food – cost-push pressures – and by the pass-through of yen weakness, rather than by strong robust consumer demand. Cost-push inflation erodes households’ real purchasing power and dampens corporate capex plans, suppressing both consumption and investment; small and mid-sized enterprises are hit especially hard.

An interest-rate differential of more than 300 basis points makes carry trades highly profitable, drawing global capital to keep "selling the yen." Each time the BOJ delivers a rate hike, markets often treat it as "the removal of policy uncertainty," prompting carry positions to be rebuilt and producing the short-lived "hike-then-weaker-yen" pattern. Like the BOJ is caught in a trap: It must hike to defend the yen, yet each hike invites fresh carry inflows that weaken it again.

For the dollar side, although the US is in an easing cycle, the American economy has shown greater-than-expected resilience — persistent inflation and a tight labor market. Beyond short-term financial-market rate differentials, the yen's weakness reflects deeper shifts in the real economy and capital-flow structure.

First, the goods balance within the current account has shifted into persistent deficit. Japan relies heavily on imports of energy, food, and electronic components. High global commodity prices and yen depreciation feed into a vicious cycle: Importers must repeatedly sell yen for dollars to pay for purchases abroad, creating structural, real-economy selling pressure on the yen.

Second, the services-trade deficit — the "digital deficit" — has widened sharply. As Japanese companies accelerate digital transformation, payments to US tech giants for cloud computing, software services, and digital advertising have surged, generating a steady stream of yen-selling demand.

Third, foreign direct investment flows largely in one direction – outward. Over past decades, Japanese firms relocated much of their manufacturing capacity overseas. Today, a large share of overseas earnings is reinvested locally rather than repatriated, so there is little natural demand to convert foreign profits back into yen.

Fourth, portfolio investment is also flowingabroad. The Japanese government's expanded NISA (Nippon Individual Savings Account) has strongly encouraged households to channel domestic savings into overseas assets such as US-equity exchange-traded funds, producing a structural capital outflow.

Historically, the yen was regarded as a natural "safe-haven currency" thanks to Japan's massive net overseas assets and persistent trade surpluses. 

Today, however, when geopolitical conflicts erupt or commodity prices spike, Japan – as a net energy importer – suffers a sharp deterioration in its terms of trade. 

The yen not only fails to serve as a safe haven but actually comes under heavier selling pressure. 

As long as the US–Japan interest-rate gap remains wide, and as long as Japan's debt burden, low growth and digital and energy trade deficits prevent it from pursuing an aggressive rate-hike cycle, modest BOJ rate increases or verbal intervention in the currency market can at best produce short-term pullbacks. 

They cannot fundamentally reverse the structural headwinds keeping the yen under sustained pressure.