A currency story with a twist: the UK’s pound is strengthening against the yen even as the Bank of England and the Bank of Japan move in opposite directions on rates. It looks like a classic bet on a widening policy gap, but the reality is more nuanced. Foreign exchange traders now focus more on fiscal policy risks and bond flows than on simple rate differentials, and the sterling/yen pair is delivering a different kind of signal.
Since mid-2024, the gap between BoJ and BoE policy rates has narrowed by about 165 basis points. That squeeze is expected to widen again this week, with the BoE anticipated to cut rates by 25 basis points to 3.75%, and the BoJ expected to raise by 25 basis points to 0.75% the following day.
Even so, the pound has risen by more than 1% against the yen over the past 18 months and has rebounded roughly 5% since mid-year, marking its strongest level against Japan’s currency in 17 years. Much of this movement mirrors broader yen weakness—a trend Japan has publicly linked to inflation concerns triggered by its stimulus measures. Since the COVID era, the yen’s real value has slumped, with the BoJ’s real effective yen index down about 30% to its weakest in over five decades, and the currency flirting with levels not seen since the 1980s against the dollar.
But the pound isn’t standing still either. The sterling’s real effective exchange rate has risen around 10% since 2020 and nudged higher by about 1% in the current year. So, the move isn’t solely a yen story; the pound has appreciated too.
If you look at markets through the lens of bond yields, the picture aligns with the currency dynamic. The 2-year gilt yield versus comparable Japanese government bonds has halved since mid-2023 and continues to drift lower, a trend not unlike what the yen has experienced. Yet the pound/yen rate has climbed about 14% in the same period. Real-yield comparisons tell a similar tale: inflation-adjusted 5-year yields favored the pound earlier in the year but have since narrowed by roughly 60 basis points. In very long maturities, where much of this year’s bond volatility has played out, the 30-year yield gap has shrunk by about 120 basis points since January.
So, why does the pound keep rising against the yen?
What’s driving the diverging moves isn’t just macro numbers at a glance. Recent OECD projections show UK and Japan on roughly equal ground for real GDP growth this year, with the UK edging ahead slightly on growth over the next couple of years, and inflation in both economies expected to converge toward about 2.1% by 2027.
If interest-rate gaps don’t fully explain currency moves, fiscal policy paths do some of the heavy lifting. Despite political noise around Britain’s budget late last month, UK fiscal policy is tightening, while Japan’s new government has embraced additional spending to spur growth.
These policy contrasts help explain why the BoE and the BoJ are diverging this week. The market’s focus may also reflect a risk premium on Japan’s renewed stimulus and the possibility that Tokyo could steer the BoJ away from tightening further, echoing episodes from Britain’s own 2022 experience in the currency markets.
A key driver appears to be cross-border investment flows. Japanese investors have become a major force in UK gilt markets, owning a substantial slice of the sector, and they bought the largest UK sovereign-bond inflow in over four years in October. If domestic uncertainty in Japan gives way to renewed buying of foreign debt, that could amplify sterling’s strength against the yen.
In the end, it’s really flows—more than just rate direction—that have shaped the current exchange rate landscape.
The opinions expressed here are those of the author, Mike Dolan, Reuters’ Editor-at-Large for Finance & Markets. They do not necessarily reflect Reuters’ official stance, and Reuters maintains its commitment to integrity, independence, and unbiased reporting.
Would you like this analysis reframed for a beginner audience, with clearer explanations of terms like basis points, yield curves, and real yields, or kept at a more market-savvy level for experienced readers? If you prefer, I can add a short glossary and a primer section explaining the key concepts.
