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The Japanese yen has been under significant pressure recently, dropping to a three-month low against the U.S. dollar. On October 18, 2023, the yen hit a low of 153.18 against the greenback, its weakest level since July 31. The yen’s decline comes amid diverging economic policies between the U.S. and Japan. In the United States, the Federal Reserve has been adopting a hawkish stance, steadily raising interest rates in response to persistent inflation. On the other hand, Japan’s central bank, the Bank of Japan (BOJ), remains steadfast in its ultra-loose monetary policies.
A critical factor in the yen’s underperformance is the widening interest rate differential between the U.S. and Japan. As the Fed continues to hike rates, offering investors higher yields on U.S. securities, there is a capital flow into U.S. dollar-denominated assets, making the dollar stronger. In sharp contrast, the BOJ’s commitment to keeping its interest rates near zero discourages investment flows into yen-denominated assets. This differential in interest rates has amplified downward pressure on the Japanese yen in the currency markets.
Market participants are wary that the weakened yen could prompt intervention by Japanese authorities. Japan’s Ministry of Finance, in collaboration with the BOJ, has historically stepped in with currency market interventions during periods of sharp yen depreciation, as seen in past instances. However, analysts are split on the likelihood of intervention this time around, as it’s not entirely clear if the BOJ would aggressively shift its monetary policy anytime soon. Many suspect that barring a significant deterioration of the yen, Japanese officials may settle for verbal warnings in the interim to curb volatility.
For Japan, a weak yen is a double-edged sword. While it helps the nation’s exporters by making Japanese goods more competitive overseas, the downside comes in the form of higher costs for imported goods, especially critical energy supplies. Japan relies heavily on imports for energy, and the weak yen exacerbates inflationary pressures on imported oil and gas prices. As a result, even though large manufacturing firms may benefit from a cheaper yen, the overall economy could face challenges with rising costs, making the situation a balancing act for policymakers.
