Bank of Japan risks, downsides and interventions By Reuters

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 U.S.-Japan interest rate differentials.

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. It continued to decline despite further interventions in April and May 2024, hitting a 38-year low of 161.96 per dollar on July 3. Japan is suspected of having intervened again in mid-July to put a floor under the yen.

The yen’s downtrend has reversed in recent days following the Bank of Japan’s July 31 decision to raise interest rates and ahead of the expected easing of US monetary policy.

The BOJ’s brutal move, along with investor concerns about US growth, rattled global equity and bond markets. That triggered a sell-off in the carry trade, whereby investors borrow cheaply in yen to invest in higher-yielding assets. The yen has rebounded sharply against the dollar, but remains relatively weak by the standards of recent decades.

The yen’s swings matter because the currency has long provided a cheap source of funding for global investors, even as other central banks have raised borrowing costs.

THE OBJECTIVE OF INTERVENTION IN CHANGING THE BOJ

Japanese authorities have historically intervened to prevent the yen from strengthening too much because a strong yen hurts the export-dependent economy. That trend changed in 2022, when Tokyo stepped in and bought the yen to defend its value after the currency collapsed on expectations that the BOJ would keep interest rates ultra-low even as other central banks tightened policy monetary policy to combat rising inflation.

In both cases, authorities buy or sell yen, usually against the dollar. The Ministry of Finance decides when to intervene, and the Bank of Japan acts as its agent.

The decision is highly political because Japan’s reliance on exports makes the public more sensitive to yen movements than in other countries. With many manufacturers now moving production overseas, the benefit of a weak yen has diminished. Instead, a weak yen has become a pain for households and retailers by inflating the cost of importing fuel and raw materials.

Tokyo intervened on April 29 and May 1 this year, according to Finance Ministry data, to combat the yen’s declines. After the moves failed to reverse the yen’s downtrend, the Japanese authorities are suspected by market participants of having intervened again several times in July.

Japanese authorities usually do not confirm whether they have intervened in the foreign exchange market and say only that they would take appropriate measures, as appropriate, against excessively volatile movements in the exchange rate.

WHY HAS THE YEN WEAKENED IN RECENT YEARS?

Various factors led to the yen’s decline.

First, the US Federal Reserve’s aggressive interest rate hikes and the BOJ’s slow pace of monetary policy normalization have kept the spread between US and Japanese interest rates high, thus keeping the yen less attractive against the dollar.

Second, Japan now imports more fuel and raw materials than in the past, which means that companies are converting yen into foreign currency to make payments.

Third, many large Japanese manufacturers that moved production overseas reinvested profits overseas rather than repatriating them. This reduced demand for the yen.

WHY NOT FASTER THE BOJ?

The BOJ ended negative interest rates in March and raised its short-term policy rate again to 0.25% from 0-0.1% in July. Governor Kazuo Ueda signaled the chance to raise interest rates again if Japan makes further progress in meeting the central bank’s 2 percent inflation target, as expected.

Analysts expect the BOJ to eventually raise interest rates to levels considered neutral for the economy, around 1% to 1.5% over the next few years. But such a gradual tightening would leave Japanese borrowing costs very low compared to other countries.

Japanese policymakers are wary of raising rates too aggressively for fear of hurting already weak consumption and threatening a fragile economic recovery. They also fear the risk of triggering a sharp rise in long-term interest rates that would raise the cost of financing Japan’s huge public debt.

WHAT ARE THE DISADVANTAGES OF A WEAK YEN?

A weak yen increases the cost of importing fuel, food and raw materials. This in turn hurts retailers and households through higher living costs.

Inflation data show that the core inflation rate, which excludes volatile fresh food prices but includes fuel costs, has been higher than the central bank’s target for the past 27 months.

WHAT ARE THE BENEFITS OF A WEAK YEN?

A weak yen, however, is not necessarily bad for Japan’s economy.

The yen’s decline benefited Japanese export firms by inflating the yen-based profits they made abroad. Rising profits can lead to higher wages and help support consumption.

A cheaper yen also boosts tourism. The number of overseas visitors to Japan has surged in the past two years, giving hotels, department stores and others relief after enduring COVID-19 restrictions.

(1 USD = 146.3100 yen)