The yen has slipped to two-decade lows against the dollar largely because Japan has a different view on inflation than its global peers. The Bank of Japan stands out among major central banks with its commitment to maintain rock-bottom interest rates to revive inflation on a sustainable basis (after years of trying to fend off deflation), even as surging prices in most of the rest of the world spur the US Federal Reserve to roll back stimulus and raise rates. A weaker yen can both benefit and harm the economy, businesses and consumers. The steepness of its slide, however, has raised questions about how tenable the BOJ’s policy is and the possibility of government intervention in currency markets.
1. Why is the yen so weak?
The biggest reason is the move toward higher interest rates in the US. That makes dollar-denominated assets more attractive for investors seeking higher returns. The yield on 10-year notes has climbed above 3% -- the highest since 2018 -- as traders continue to bet on an aggressive series of rate hikes from the Federal Reserve. Other factors include the strength of the US economy and its labor market, while Japan continues to lag behind its peers to bring its economy back to its pre-pandemic size. Japan’s trade balance staying in the red is also likely feeding into the weaker yen.
2. Why doesn’t Japan raise rates?
BOJ Governor Haruhiko Kuroda keeps saying it’s too early to cut back monetary easing and raise rates in Japan, where inflation remains relatively muted. In April, Japan’s benchmark inflation measure rose 2.1%, above the BOJ’s 2% target. But Kuroda insists that it’s not yet expected to stay above the goal in a stable, sustainable manner, especially without robust wage increases. By contrast, US consumer prices have been rising more than 8%. While Kuroda has continued in June to insist he won’t change course, he famously rattled markets with a surprise shift to negative interest rates in 2016, before eventually settling on the current policy, which is known as yield curve control.
3. What’s a yield curve?
It’s a way to show the difference in the reward investors get for choosing to buy shorter- versus longer-term debt. Most of the time, they demand more for locking away their money for longer periods, with the greater uncertainty that brings. So yield curves usually slope upward.
4. What’s yield curve control?
Normally market forces determine the yield curve. The BOJ takes a more hands-on approach. Through yield curve control, adopted in 2016, it aims to keep 10-year government bond yields around 0% with a quarter of a percentage point, or 25 basis points, of wiggle room either side -- part of its effort to flood the economy with cheap money to revive growth. The Fed’s interest rate hikes prompted investors to speculate that Japan would follow suit, meaning it would allow the yield to go higher.
5. What happens if the BOJ drops yield curve control?
It seems very unlikely. But, just like when the Swiss National Bank unexpectedly abandoned its cap on the franc in 2015, a surprise U-turn by the BOJ has the potential to spark shock waves around the world. If the BOJ even indicated it would scale back its asset purchases or overhaul its yield curve control, that would likely intensify market volatility and hammer Japanese stocks. Japanese government bonds would likely see a knee-jerk selloff, adding to upward pressure on borrowing costs globally. The yen would most likely rally so sharply that it would whip up foreign-exchange markets and damage any traders using it to fund so-called carry trades, or multinationals and banks with large, unhedged currency exposure. How long the sell-off lasts would be anyone’s guess, as domestic investors flush with cash could step in quickly to buy the bonds on dips. Still, Jim Reid from Deutsche Bank AG said such a move would have “huge implications for global rates” if it came to pass. “If the BOJ throws in the towel,” he wrote in a June 14 report, “then global bond markets lose a huge anchor.”
6. What has the BOJ done?
After a wave of pressure pushing the yields higher, the bank doubled down on its commitment to keep a lid on them. It decided in April it would buy as many bonds as needed every business day to protect the 0.25% ceiling on 10-year debt yields. That made it clear bond yields in Japan will stay low even as they rise in the US.
7. Could the government intervene?
Finance Minister Shunichi Suzuki has refrained from even mentioning the possibility of direct intervention in the currency market. If the government intervenes to strengthen the yen, it would be the first time since 1998, when it and the US joined in a massive coordinated yen-buying spree. Any one-sided moves from Japan this time would likely trigger some form of protest from the US side.
8. What does the weak yen mean for the economy?
When former Prime Minister Shinzo Abe ushered in a period of a weaker yen in the last decade in part to stave off the threat of deflation (a downward spiral that can wreck economies), the business world largely applauded. A cheaper yen helps exporters including carmaking giant Toyota Motor Corp. 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. The mood is shifting now though. Costs for commodities and other goods are rising at the fastest pace in decades, squeezing profits at businesses that rely on imports, while everyone is feeling the pinch from higher energy prices. The rising cost of imported food and other daily necessities is piling on pain for consumers. While Japan is gradually reopening its borders to overseas visitors, any economic benefits from that will be limited for the time being. With the central bank unlikely to budge, Prime Minister Fumio Kishida put together a raft of relief measures including higher fuel subsidies to ease the impact for households and businesses.
9. Where does this leave Kuroda?
It’s an awkward way to spend the last year of his second five-year term as governor. But he’s maintained his stance that a weak yen is good for the economy as a whole, sticking to protecting the credibility of his policy framework. Kuroda often points out it’s the finance ministry, not the BOJ, that is in charge of foreign exchange matters. Low borrowing costs also help Kishida, the prime minister, keep increasing public spending to aid a fragile economy recovery from the pandemic. That suggests he won’t likely be pushing hard for regime change at the central bank when Kuroda’s term ends next April.
(Adds new section 5 on possible repercussions of abandoning yield curve control)
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