The Weak Yen Problem

No easy solution

By Takuya Nishimura, Senior Fellow, Former Editorial Writer for The Hokkaido Shimbun
The views expressed by the author are his own and are not associated with The Hokkaido Shimbun
You can find his blog, J Update here.
May 6, 2024. Special to Asia Policy Point

The yen-to-dollar exchange rate has moved in unusual ways over the past week. The foreign exchange market’s expectation that the gap between the low interest rate in Japan and the higher interest rate in the United States will not narrow soon has caused the yen to depreciate. Frustrated with this development, the Bank of Japan apparently has intervened at least twice in the FX market, once on April 29 and again on May 2, to increase the yen’s value against the US dollar. Yet so long as inflation persists in the US economy as it has done over the past few years, the weakness in the yen cannot be remedied, unless the BOJ plans to increase the inflation rate, which would complicate monetary policy.

The yen began its recent journey through the foreign exchange markets on April 26. At a press conference that day, the governor of the Bank of Japan, Kazuo Ueda, said that “Depreciation of yen has had no major influence on underlying inflation so far.” He insisted that monetary policy would not attempt to address foreign exchange rates. He also did not indicate when the Bank would start reducing its purchase of Japanese government bonds.

The market interpreted Ueda’s comments as a sign that the BOJ would not raise interest rates for the time being. That being so, the market believed that the wide interest rate gap between Japan and the U.S. would continue for some time. Money is generally supposed to flow to a currency with a higher interest rate. After the BOJ’s monetary policy meeting, at which the interest rate was left unchanged, the yen was sold, and the dollar was bought. At mid-day on April 29, the foreign exchange rate reached 160 yen against U.S. dollar for the first time since 1990.

A curious trend then began within the hour. The rate rose to 155 yen against dollar, dipped to 157 yen to the dollar, and then settled at 154 yen. These abrupt ups and downs invited speculation that the government of Japan had intervened in the foreign exchange market – unannounced. The Vice Minister of Finance for International Affairs, Masato Kanda, refused to comment. However, looking at the BOJ’s account balance, news organizations reported that the BOJ was likely to have intervened at the request of Ministry of Finance. The BOJ’s estimated current account balance dropped 7.56 trillion yen between April 29 and 30. When this balance drops, foreign exchange firms will experience offsetting increases. However, between April 29 and 30, the firms’ balances increased between 2.05 and 2.3 trillion yen.

The 5 trillion yen gap between the BOJ and the firms is thought to be the amount of the BOJ’s intervention on April 29. This amount approached the BOJ’s largest single-day intervention of 5.6 trillion yen in October 2022.

But the unusual moves in the foreign exchange market did not stop there. After the likely intervention on April 29, the yen still exhibited gradual weakness. Just after the Federal Open Market Committee of the U.S. Federal Reserve Board announced, on the afternoon of May 1 (U.S. Eastern Daylight Time) and the early morning of May 2 in Japan time, that it would leave the target range for the federal funds rate unchanged, the yen suddenly rose from 157 yen against dollar to 153 yen. The consensus view is that the BOJ had intervened again to the tune of 3 trillion yen.

The market was surprised at the second intervention because the yen seemed to be appreciating. The U.S. announcement of no change to the federal funds rate had stimulated purchases of yen. The market previously expected BOJ to intervene when the exchange rate reaches 160 yen to the dollar. The second possible intervention on May 2 occurred before the rate had reached that level, thus clouding expectations of when the BOJ would defend the yen. The exchange rate rose further to 151 yen to the dollar on May 3, after the U.S. jobs report showed a slowdown in hiring. The U.S. Labor Department announced an increase in payrolls of approximately 175,000, well below predictions of approximately 243,000.

The BOJ appears to have intervened in the foreign exchange market because the negative impact of the weak yen on the Japanese economy cannot be ignored. “If excessive fluctuation occurred by speculations, it poses negative impact on people’s life. We firmly deal with it,” said Kanda when asked about the first intervention on April 29.

A weak yen causes the prices of imported goods to rise and exerts downward pressure on real wages. Prime Minister Fumio Kishida has focused on returning the fruits of economic growth to the people, expecting that wages would rise faster than prices. He has also planned a tax cut for June. A depreciating yen may erode the effect of the economic policies of the Kishida administration, which is suffering from historically low approval ratings. Intervention in the foreign exchange market is unavoidable for the administration.

However, the effect of any intervention will be limited. The weak yen is the result not just of the interest rate gap between Japan and the U.S., but also of the relative strength of the two economies. Inflationary pressure is still strong in the United States. Wages are growing at a relatively high rate, encouraging consumption that leads to inflation. The Chair of the Fed, Jerome Powell, said in his press conference on May 1 that the members of the FOMC “do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2 percent.” Alternatively, the members “are also prepared to respond to an unexpected weakening in the labor market,” he said.

The Fed has shown no sign of another increase in the target rate, but U.S. wages are still increasing. The BOJ’s intervention in the foreign exchange market has no realistic chance of narrowing the interest rate gap with the United States.

Intervention is not a popular tool for adjusting foreign exchange in the international economy. U.S. Treasury Secretary Janet Yellen said that currency interventions should occur only in “very rare and exceptional circumstances,” when markets are disorderly with excessive volatility. Whether the interventions will help the Kishida administration to survive the aftermath of the slush fund scandal is uncertain.