Consistently weaker yen keeps Japanese policymakers on guard

With the yen trending down most of the year - as the US continues to maintain high policy rates while Japan has kept them low - Japanese authorities are facing renewed pressure to combat a sustained depreciation in the currency.
The down trend persists even as the pace of inflation is now about the same in Japan as in the US. That’s partly because the Bank of Japan still thinks price growth has yet to get settled in the minds of consumers and businesses.
The yen has been the worst performer this year among major currencies against the US dollar, falling about 11%. That’s mainly because Japanese interest rates remain low to nurture inflation while the US and others have hiked them to cool price growth, making dollar-denominated assets more attractive for investors.
The Bank of Japan (BoJ) has loosened its grip on Japan’s 10-year government bond yields, but it keeps rates low to support the economy, which has contracted in the quarter through September.
Yields on Treasuries remain relatively high as the Federal Reserve stands ready to hike rates more if needed to cool inflation and the economy.
BoJ Governor Kazuo Ueda has yet to become confident that inflation will be anchored beyond the bank’s 2% goal in the long term while being accompanied by sufficient wage gains, and so far the government hasn’t declared an end to its long fight against deflation.
The yen’s decline has both benefited and harmed the economy, businesses and consumers.
The currency’s fall to 24-year lows has repercussions for the domestic economy as yen-based import prices are surging at a record annual pace, heaping pressure on household balance sheets.
On the other hand, a cheaper yen helps exporters when they repatriate profits made overseas.
It also makes Japan a more affordable travel destination - outside of pandemic times - for foreigners, bringing tourist cash for the hospitality sector and regional economies.
On the downside, a soft yen makes imports of energy and food more expensive, hitting consumers whose paychecks are not keeping up with the rise in living costs. Their ongoing angst has weakened public support for Prime Minister Fumio Kishida.
The premier has put together another economic stimulus package to ease the pain of inflation, which in return prolongs the BoJ’s efforts to nurture inflation. This sets Japan apart from other major economies that have focused on monetary policy to curb price gains.
Policymakers remain on guard to see if they need to curb its decline through currency intervention as they did in 2022. Last year, they intervened multiple times to support the yen.
US Treasury Secretary Janet Yellen said this year that any intervention by Japan to prop up the yen would be understandable if it were aimed at smoothing out volatility — not at affecting the level of the exchange rate.
While Japan holds nearly $1.3tn in foreign reserves, these could be substantially eroded if Tokyo intervened heavily repeatedly, leaving authorities constrained over how long they can defend the yen.
Japanese authorities also consider it important to seek the support of Group of Seven partners, notably the United States if the intervention involves the dollar.
Can the yen fall further?
It largely depends on whether the interest rate gap between Japan and the US widens or narrows. A bigger gap means more downward pressure on the yen. A smaller gap would support the yen.
The yen has long been the currency of choice for investors undertaking carry trades, which involve borrowing in a low-yielding currency like the yen to invest in higher yielding counterparts like the US, or Canadian dollars.
But the yen’s enduring volatility and weakness could undermine its appeal as a funding currency.