In sinusoidal phase-modulating laser diode interferometers, an injection current of a laser diode is sinusoidally modulated to scan the laser wavelength. However, the modulation of the injection current also involves an intensity modulation of the light, which increases the measurement error if a conventional signal processing is used. A novel signal processing for displacement measurement is proposed to eliminate the influence of the intensity modulation. Numerical simulation results and experimental results make it clear that an optimal depth of the sinusoidal phase modulation exists that can reduce the measurement error to a few nanometers.