By Leika Kihara, Pasit Kongkunakornkul, Vineet Sachdev and Kripa Jayaram
(Reuters) – The Japanese yen has been under pressure in recent years as markets focused on wide interest rate differentials between the U.S. and Japan.
The yen has lost more than 20% against the dollar since the start of 2022, prompting several rounds of intervention by Tokyo to support the currency in September and October of that year. Despite further interventions in April and May 2024, the rate continued to fall, reaching a 38-year low of 161.96 against the dollar on July 3. Japan is said to have intervened again in mid-July to put a floor under the yen.
The yen’s downward trend has reversed in recent days, following the Bank of Japan’s July 31 decision to raise interest rates and ahead of an expected easing of US monetary policy.
The BOJ’s aggressive action, along with investor concerns about U.S. growth, shocked global stock and bond markets. It caused an end to the carry trade, where investors borrow cheap yen to invest in higher-yielding assets. The yen recovered sharply against the dollar, but remains relatively weak by the standards of recent decades.
The yen’s swings matter because the currency has long been a cheap source of funding for global investors, even as other central banks raised borrowing costs.
BOJ’S SHIFTING INTERVENTION TARGET
Japanese authorities had historically intervened to prevent the yen from rising too much, because a strong yen hurt the export-dependent economy. This trend changed in 2022, when Tokyo stepped in and bought the yen to defend its value after the currency tumbled on expectations that the BOJ would keep interest rates ultra-low even as other central banks tightened monetary policy to combat rising inflation to go.
In both cases, the authorities buy or sell the yen, usually against the dollar. The Ministry of Finance decides when to intervene and the Bank of Japan acts as agent.
The decision is highly political in nature, as Japan’s dependence on exports makes the public more sensitive to yen movements than in other countries. With many manufacturers moving production abroad, the benefit of a weak yen has diminished. Instead, a weak yen has become a burden on households and retailers as it has driven up the cost of importing fuel and raw materials.
Tokyo intervened on April 29 and May 1 this year to counter the yen’s decline, according to Finance Ministry data. After the moves failed to reverse the yen’s downward trend, market participants suspect that Japanese authorities have again intervened repeatedly in July.
Japanese authorities generally do not confirm whether they have intervened in the foreign exchange market, saying only that they will take appropriate action against excessively volatile currency movements if necessary.
WHY HAS THE YEN WEAKENED IN RECENT YEARS?
Several factors caused the yen to fall.
First, aggressive rate hikes by the US Federal Reserve and the BoJ’s slow pace of monetary policy normalization kept the gap between US and Japanese interest rates wide, leaving the yen less attractive compared to dollars.
Second, Japan is now importing more fuel and raw materials than in the past, meaning companies are converting yen into foreign currency to make payments.
Third, many major Japanese manufacturers that have moved production abroad have reinvested their profits abroad, rather than repatriating them. That reduced demand for the yen.
WHY DOESN’T THE BOJ RAISE PRICES FASTER?
The BOJ ended negative interest rates in March and raised short-term rates again to 0.25% from 0-0.1% in July. Governor Kazuo Ueda has indicated there is an opportunity to raise rates again if Japan makes further progress toward meeting the central bank’s 2% inflation target, as it proposes.
Analysts expect the BOJ will eventually raise rates to levels considered neutral for the economy, around 1% to 1.5% in the coming years. But such gradual tightening would keep Japan’s borrowing costs very low compared to other countries.
Japanese policymakers are cautious about raising rates too aggressively for fear of hurting already weak consumption and threatening a fragile economic recovery. They are also wary of the risk of a sharp rise in long-term interest rates, which would increase the cost of financing Japan’s massive government debt.
WHAT ARE THE DISADVANTAGES OF A WEAK YEN?
A weak yen drives up the costs of importing fuel, food and raw materials. That in turn hurts retailers and households through higher costs of living.
Inflation data shows that the pace of core inflation, which excludes volatile fresh food prices but fuel costs, has exceeded the central bank’s target over the past 27 months.
WHAT ARE THE ADVANTAGES OF A WEAK YEN?
However, a weak yen is not necessarily all bad for the Japanese economy.
The decline in the yen benefited Japanese export companies by inflating the yen-based profits they earned abroad. The higher profits can lead to higher wages and help support consumption.
A cheaper yen also stimulates tourism. The number of foreign visitors to Japan has surged in recent years, providing hotels, department stores and other relief from ongoing COVID-19 restrictions.
($1 = 146.3100 yen)
