Continued yen depreciation keeps policymakers of Japan on guard

Just as the yen has been grappling with continued depreciation, so the currency’s weakness is now seen as problematic, with Japanese firms having shifted production overseas and the economy heavily reliant on imports for goods ranging from fuel and raw materials to machinery parts.
The yen has been one of the worst performers this year among major currencies against the US dollar, falling more than 6%. That’s mainly because of the wide gap in interest rates between Japan and the US.
Even after the recent historic rate hike, Japan’s new policy rate is by far the lowest in the developed world, at a range of between 0% and 0.1%.
The yen’s trajectory will largely depend on the trajectory of the interest rate gap.
Bank of Japan Governor Kazuo Ueda has made it clear Japan’s overall policy settings will remain accommodative, meaning he’s unlikely to raise rates fast or by a lot.
Generally, a weaker yen helps large Japanese companies with global operations because it increases the value of repatriated overseas profits.
A weaker currency can also help tourism by boosting the buying power of incoming travellers. Visitor numbers and their spending have recovered strongly to exceed pre-pandemic levels.
On the downside, a soft yen makes imports of energy and food more expensive, hitting consumers. Earlier in March, the nation’s largest umbrella group of unions secured the latest wage hikes in decades for the coming fiscal year.
Wage gains exceeding inflation may give consumers more confidence about spending. Prime Minister Fumio Kishida hopes one-off tax cuts starting in June will support consumer sentiment, too.
Investors and economists are split over whether the BoJ is finished with raising interest rates this year or will make another move. Ueda has said if inflation runs hotter than expected, another rate hike would be on the table.
The key point will be whether consumption recovers. That would make it easier for the BoJ to raise rates again, as it could claim that resilient domestic demand fuelled by wage hikes is making demand-led inflation sustainable.
If consumption fails to pick up despite wage growth, the economy will lose momentum, making it harder for the BoJ to justify another hike.
Japan last intervened in October 2022 as the yen plumbed lows near 152 per dollar. It was then estimated to have spent as much as ¥9.2tn ($60.78bn) defending the currency.
Japan’s finance minister, who is in charge of currency policy, has been issuing stronger and stronger verbal warnings meant to put a floor under the yen, but authorities haven’t taken direct action in the market. US Treasury Secretary Janet Yellen said last 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 absolute level of the exchange rate.
But yen-buying intervention is more difficult than yen-selling.
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 US, if the intervention involves the dollar.
Washington gave tacit approval when Japan intervened in 2022. There is uncertainty on whether the same will happen when Japan next considers intervention.
A looming US presidential election may discourage Japanese authorities from stepping in, given the risk of drawing unwanted attention and criticism from Washington as market meddling.
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.