Authors: Leika Kihara, Pasit Kongkunakornkul, Vineet Sachdev and Kripa Jayaram

(Reuters) – The Japanese yen has been under pressure in recent years as markets have focused on the wide interest rate differential between the U.S. and Japan.

The yen has fallen more than 20% against the dollar since the start of 2022, prompting Tokyo to intervene several times to prop up the currency in September and October of that year. It continued to fall despite further intervention in April and May 2024, hitting a 38-year low of 161.96 per dollar on July 3. Japan is suspected of stepping in again in mid-July to set a lower bound under the yen.

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

The BOJ’s hawkish move, along with investor concerns about U.S. growth, has rattled global stock and bond markets. It has triggered a reversal in the carry trade, in which investors borrow cheaply in yen to invest in higher-yielding assets. The yen has rebounded sharply against the dollar but remains relatively frail by the standards of the past few decades.

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

THE CHANGING TARGET OF WAR INTERVENTION

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

In both cases, the authorities buy or sell yen, usually against the dollar. The Ministry of Finance decides when to step in, with the Bank of Japan acting as its agent.

The decision is highly political, as Japan’s dependence on exports makes society more sensitive to yen movements than in other countries. With many manufacturers moving production overseas, the benefits of a frail yen have diminished. Instead, the frail yen has become a drag on households and retailers, making it more exorbitant to import fuel and raw materials.

Tokyo intervened on April 29 and May 1 of this year, according to Finance Ministry data, to counter the yen’s declines. After the moves failed to reverse the yen’s downward trend, market participants suspect Japanese authorities intervened again on several occasions in July.

Japanese authorities generally do not confirm whether they have intervened in the currency market. They have said only that they will take appropriate action if necessary in response to excessively volatile exchange rates.

WHY HAS THE YEN WEAKEN IN RECENT YEARS?

Many factors contributed to the depreciation of the yen.

First, the aggressive rate hikes by the US Federal Reserve and the tardy pace of monetary policy normalization by the BOJ meant that the spread between US and Japanese interest rates remained wide, making the yen less attractive against the dollar.

Second, Japan now imports more fuel and raw materials than in the past, which means companies must exchange yen for foreign currencies to make payments.

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

WHY DON’T BOJ RAISE HIS FEET FASTER?

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

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 gradual tightening would make Japanese borrowing costs very low compared with other countries.

Japanese policymakers have been wary of raising rates too aggressively, fearing that doing so would hurt already frail consumption and threaten a frail economic recovery. They also fear the risk of triggering a pointed rise in long-term interest rates, which would boost the cost of financing Japan’s massive public debt.

WHAT ARE THE DISADVANTAGES OF A WEAK YEN?

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

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

WHAT ARE THE BENEFITS OF A WEAK YEN?

However, a frail yen does not have to be bad for the Japanese economy.

The yen’s fall has benefited Japanese exporting companies, boosting the yen-denominated profits they make overseas. The rise in profits could lead to higher wages and aid sustain consumption.

A cheaper yen is also boosting tourism. The number of foreign tourists visiting Japan has soared in the past few years, giving hotels, department stores and others a reprieve as COVID-19 restrictions ease.

(1 dollar = 146.3100 yen)