The Japanese yen, after adjusting for prices, is at its limits Lowest level Since the early seventies. In times past, such weakness would have led to recriminations between Tokyo and Western capitals, which lived in fear of cheap Japanese imports. not longer. Today’s weak yen is causing resentment within Japan, not without it. There are demands for the Bank of Japan raise interest rates. This would be a mistake. Although painful in the short term, the current bout of yen weakness is not so much a problem as a new opportunity for the Bank of Japan to achieve its multi-decade goal: deflation in the Japanese economy.
When the Bank of Japan last week doubled down on its pledge to keep 10-year bond yields close to zero per cent, the market reaction was immediate, with the yen dropping to 130 yen against the dollar. The Japanese currency began to decline in 2021 as it became clear that the US Federal Reserve would raise interest rates, creating a widening gap in yields across the Pacific. The downturn accelerated in March after Russia’s invasion of Ukraine sent oil and gas prices skyrocketing. It was a bad shock to Japan’s terms of trade, importing commodities.
The depreciation of the yen along with the rise in oil prices is causing painful inflation in Japan. Families notice high prices for petrol at the pumps and food in supermarkets. But this reflects weakness, not strength, in the Japanese economy. Wages are hardly going up at all. Thus the Bank of Japan believes, and rightly so, that the economy still needs support. Inflation, driven by cost alone, will not be sustainable. Instead, we need to see economic recovery. . . “We don’t see the conditions in place right now for that to happen,” Governor Haruhiko Kuroda said at his press conference after the meeting.
The question is whether the lower rates and the falling yen will prove acceptable to the government of Prime Minister Fumio Kishida, who must run for the upper house in a few months and is under pressure to do something about the pressure on living standards. Kishida broadly has two options. He can intervene in the currency markets to support the yen. Or he may seek to replace Kuroda with a tougher figure when the governor’s term expires next year.
The yen’s intervention falls into the category of policies that may do little and do little harm. Japan has $1.2 trillion in foreign exchange reserves, which it accumulated during previous interventions when the yen was very strong, not too weak. These reserves serve little purpose. Selling some while the yen is weak and using the proceeds to draw down public debt wouldn’t be crazy. Most of the available evidence suggests that such an intervention, sterilized so that it does not affect the domestic money supply, will have little effect in the medium term on the exchange rate.
By contrast, pressure for a hawkish BoJ turnaround would do a great deal of damage and not do any good. With the Japanese economy struggling to recover after Covid-19, with no domestically generated inflation to speak of, the last thing its economy needs is to make credit more expensive. Instead, a weak yen is an opportunity to stimulate exports – even if Japan is no longer the currency-sensitive export machine it once was – and bring inflation closer to the Bank of Japan’s 2 per cent target. Kuroda argued that “a weak yen is positive for the Japanese economy as a whole.” In this, he is right.
The rest of the world used to worry about cheap Japanese exports. If the lower yen now makes Japanese exports cheaper, it will be export deflation: exactly what the inflation-stricken US wants right now. So the weak Japanese currency suits the economies on both sides of the Pacific. The BoJ should continue its course and let the yen slide.