How the World Works
Mechanic 04 · Currencies

How exchange rates move prices and trade

An exchange rate is the price of one currency in another. When the yen falls against the dollar, every barrel of oil, every imported component and every trip abroad costs Japan more. This page explains what moves currencies, how a weaker one turns into higher prices, and when central banks step in, with Japan as today’s case.

1 · Key concepts

The terms you need

Each definition is followed by a real example from the latest data.

Exchange rate
The price of one currency in terms of another. When a currency weakens, imports cost more and exports become cheaper for foreign buyers.
Example: At about 157 yen per US dollar, the yen is weak by historical standards.
Interest rate differential
The gap between interest rates in two countries. Investors tend to move money towards the higher rate, so a wider gap usually supports the higher-yielding currency, and a narrower gap weakens it.
Example: US 10-year yield 4.96% − Japan 10-year 2.96% = a gap of about 2.0 points, down from about 3.9 in October 2023.
Imported inflation
Inflation that comes from abroad: higher prices for imported goods and energy, or a weaker currency that makes every import more expensive.
Example: Japan buys oil in dollars. With the yen near 157 per dollar, each barrel costs more in yen than it did when the yen was stronger.
Exchange-rate pass-through
How much of a change in the exchange rate shows up in prices at home. It is usually partial and slow: importers and shops absorb some of the change, and imports are only part of what people buy.
Example: Oil priced in dollars passes through almost fully and quickly. A car assembled at home from some imported parts passes through much less.
Trade balance
Exports minus imports over a period. A deficit means a country buys more from abroad than it sells, so it needs foreign currency to pay the difference.
Example: Japan ran a trade deficit of ¥2.81tn ($17.8bn) between April and September 2026.
Current account
The broadest measure of a country’s transactions with the rest of the world: the trade balance, plus income earned on foreign investments, plus transfers. A deficit has to be financed by borrowing from foreigners or selling assets to them.
Example: Japan usually runs a current account surplus, because its large foreign investments earn income, even in years when its trade balance is in deficit.
Currency intervention
When a government or central bank buys or sells currencies to move its exchange rate. To support a weak currency, it sells foreign reserves, usually dollars, and buys its own currency.
Example: Japan sold dollars to buy yen in 2022, when a dollar cost about 146 and then 152 yen, and again in 2024, when it neared 160.
Policy rate
The short-term interest rate a central bank sets. It anchors what banks pay to borrow from each other overnight, and from there flows into loan and savings rates. Its name differs by country.
Example: The Bank of England’s policy rate is called Bank Rate, currently 3.75%.
2 · How it works

From a falling currency to higher prices

A currency moves first. Prices follow, partly and with a delay. Then the central bank or the government may respond.

  1. 1 →Money movesInvestors shift money between countries, chasing higher interest rates or safety. Trade flows add to it: importers need foreign currency to pay their bills.
  2. 2 →The currency weakensMore money leaving than arriving pushes the price of the currency down. It takes more yen to buy one dollar.
  3. 3 →Import prices riseOil, food and components priced in dollars cost more in local currency, even if their dollar price hasn’t changed.
  4. 4 →Inflation and trade adjustSome of the rise reaches shop prices. Exporters gain, because their goods get cheaper for foreign buyers.
  5. 5The responseThe central bank may raise rates to attract money back. The government may intervene, selling reserves to buy its own currency.
What moves a currency
Rate gaps + trade flows + appetite for risk

Higher interest rates attract money, so the gap between two countries’ rates matters most over months. A trade deficit means a steady need for foreign currency. And in a panic, money runs to safe havens such as the dollar.

How much reaches prices
10% weaker currency → dollar-priced imports up about 10% in local money

That is the first step only. Shop prices rise much less, because imports are just part of what people buy and companies absorb some of the cost. Economists call the share that gets through pass-through.

How a country defends its currency
Raise rates, or sell reserves

Higher interest rates make the currency more attractive to hold. Intervention works faster, but its effect fades unless the underlying causes change. Japan sold dollars to buy yen in 2022 and again in 2024.

For comparison
Asia, 1997–98

When Thailand stopped defending the baht in July 1997, investors pulled money out of the region. The baht, the Korean won and the Indonesian rupiah lost more than half their value against the dollar within months, and import prices soared.

A different model
Singapore steers its currency, not an interest rate

Because imports are so large relative to its economy, Singapore’s central bank, MAS, fights inflation by guiding the Singapore dollar’s value against a basket of currencies, instead of setting a policy interest rate.

3 · Today’s numbers

The yen: weak despite a narrowing rate gap

~158Yen per dollar, mid-October
154A year earlier
2.0 ptsUS–Japan 10-year gap
3.9 ptsThe same gap, Oct 2023
140150160170158.0Oct 23Apr 25Oct 26
Yen per US dollar, month-end values. Latest: 158.0 on 16 Oct 2026. Source: Federal Reserve (via FRED).
100200300400200 bpOct 23Apr 25Oct 26
10-year Treasury minus 10-year JGB, monthly, basis points. Source: US Treasury (via FRED); OECD (via FRED).

What stands out today

  • The gap between US and Japanese 10-year yields has almost halved since October 2023, as Japan’s rates rose. On interest rates alone, that should have lifted the yen.
  • It hasn’t: a dollar still buys about 158 yen, more than a year ago.

Why the yen stays weak

Other forces are pushing the other way. The oil shock has swollen Japan’s import bill, so Japanese buyers need more dollars, and the trade balance has been in deficit for five months in a row.

4 · In the news

This mechanic in the news

Recent stories that show this mechanism at work, newest first.

External shock → trade & yenEffect Japan’s oil bill pushes its trade balance into deficit for a fifth month The April–September deficit reached ¥2.81tn ($17.8bn). Imports rose 20%, and the yen is near 157 to the dollar. Japan imports almost all its oil, and pays for it in dollars. A blocked shipping route and a weak yen are a costly combination. 24 Oct 2026 · Japan
All news →

Sources and notes

  • Exchange rates: Federal Reserve noon buying rates (via FRED), month-end values; they run about a week behind the market.
  • 10-year yields: US Treasury daily (via FRED); Japan, OECD monthly averages (via FRED). The gap compares month-end US yields with Japan’s monthly average.
  • Intervention dates: Japan Ministry of Finance announcements, 2022 and 2024. Asia 1997–98: historical exchange rates.
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