Why the yen is so weak and what it means for Japan

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The yen weakened past 140 to the dollar for the first time in nearly a quarter century, mainly because Japan’s central bank kept interest rates low while the Federal Reserve and other central banks are making outrageous rate hikes. Price growth in Japan is much cooler than in the United States, and the Bank of Japan believes it needs to do more to cement inflation in the minds of consumers and businesses after years of deflation. The historic fall of the yen has both benefited and harmed the economy, businesses and consumers. The extent of its fall raises questions about whether policymakers should stem its decline through monetary intervention or a change in BOJ policy.

1. Why is the yen so weak?

The main reason is the US tendency to raise interest rates, while Japanese rates remain low, making dollar-denominated assets more attractive to investors. Treasury yields climbed as traders bet the Fed will continue to hike rates aggressively, while the BOJ maintains a 0.25% cap on the yield on 10-year government bonds from the Japan. Japan’s economic recovery remains relatively subdued and its persistent trade deficit is also adding downward pressure on the yen.

2. Why isn’t Japan raising rates?

BOJ Governor Haruhiko Kuroda has repeatedly said it is too early to reduce monetary easing as the long fight against deflation is not yet over. Inflation has accelerated past the BOJ’s 2% target, but the bank says the trend is not sustainable and expects inflation to slip below the target in the year beginning April 2023. Kuroda insists bigger wage gains are needed to ensure stable inflation.

Kuroda expressed concern about the sharp weakening of the yen, but clarified that the currency would not lead to a change in BOJ policy.

3. What does the weak yen mean for the economy?

Generally, a weaker yen helps large Japanese companies operate globally, as it increases the value of profits repatriated overseas. Partly thanks to the falling yen, Japanese corporate profits have risen to their highest levels since 1954. A weak currency can also help tourism by increasing the purchasing power of foreign travelers, but Japan is not benefiting again due to pandemic border controls. . In contrast, a weak yen makes energy and food imports more expensive, hitting consumers whose paychecks are not keeping up with the rising cost of living. Their growing angst has weakened public support for Prime Minister Fumio Kishida. The prime minister backed the BOJ’s policy by increasing government spending to limit the impact of rising prices. This sets Japan apart from other major economies that have focused on monetary policy to curb inflation.

4. What does this mean for Kuroda?

With continued government support, Kuroda is expected to largely keep interest rates unchanged until the end of his term in April, even as the yen continues to weaken. The governor often points out that it is the Ministry of Finance, not the BOJ, that is in charge of foreign exchange matters. Low borrowing costs are also helping Kishida continue to increase government spending to help Japan’s economy recover from the pandemic.

5. Could the government intervene?

Finance Minister Shunichi Suzuki did not hint at direct intervention in the currency market as an imminent possibility. If the government were to intervene in the markets to strengthen the yen, it would be the first time since 1998, when it and the United States joined in a massive and coordinated yen buying spree. Suzuki and other officials are hoping that verbal warnings will be enough to slow the yen’s current slide. With the US focused on fighting inflation and the weak yen so closely tied to Japanese monetary policy, joint intervention with the US faces a high bar. Unilateral interventions to support the yen in the past have proven largely ineffective.

6. Can the yen fall further?

Much depends on how high the Fed will raise rates. The higher the treasury yields, the wider the rate spread between Japan and the US will be, as the BOJ maintains its cap on domestic bond yields. The Fed’s interest rate hikes earlier this year prompted investors to bet on Japan. Speculation of a possible change still exists, but has mostly receded after the BOJ repeatedly showed its commitment to defending its yield cap. The yen’s slide could stop once investors finish evaluating Fed rate hikes or the US slips into a recession, weakening the dollar.

More stories like this are available at bloomberg.com

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