The Japanese yen, adjusted for prices, is at its lowest level since the early 1970s. In times gone by, such weakness would have prompted furious recriminations between Tokyo and western capitals, which lived in fear of cheap Japanese imports. No longer. Today, the weakness of the yen prompts discontent inside Japan, not without. There are demands for the Bank of Japan to raise interest rates. This would be a mistake. Although painful in the short-term, the current bout of yen weakness is less a problem than a fresh opportunity for the BoJ to achieve its goal of many decades: reflation of the Japanese economy.
When the BoJ doubled down last week on its pledge to keep ten-year bond yields close to zero per cent, the market reaction was immediate, with the yen falling through ¥130 against the dollar. Japan’s currency started to slide in 2021 as it became apparent the US Federal Reserve would raise interest rates, creating a widening gap in yields across the Pacific. The decline accelerated in March after Russia’s invasion of Ukraine caused a jump in oil and gas prices. That was a nasty shock to the terms of trade for commodity-importing Japan.
A falling yen, combined with rising oil prices, leads to painful inflation in Japan. Households notice a rise in the price of petrol at the pumps and food in the supermarkets. But this reflects weakness and not strength in the Japanese economy. Wages are hardly rising at all. The BoJ thus believes, correctly, that its economy still needs support. “Inflation, driven by cost-push alone, won’t be sustainable. Rather, we need to see an economic recovery . . . to boost consumption and capital expenditure, and lead to a moderate increase in trend inflation,” said governor Haruhiko Kuroda at his post-meeting press conference. “We’re not seeing conditions fall in place now for that to happen.”
The question is whether low rates and a falling yen will prove acceptable to the government of prime minister Fumio Kishida, who must contest upper house elections in a few months, and is under pressure to do something about the squeeze on living standards. Kishida broadly has two options. He could intervene in currency markets to support the yen. Or he could seek to replace Kuroda with a more hawkish figure when the governor’s term expires next year.
Yen intervention falls into the category of policies that would do little good and little harm. Japan holds $1.2tn in foreign currency reserves, which it amassed during past interventions when the yen was too strong rather than too weak. These reserves serve little purpose. Selling some while the yen is weak and using the proceeds to retire public debt would not be a crazy thing to do. Most of the available evidence suggests that such an intervention, sterilised so it did not affect the domestic money supply, would have little medium-term impact on the exchange rate.
Pushing for a hawkish turn at the BoJ, by contrast, would do a great deal of harm and almost no good. With Japan’s economy struggling to recover after Covid-19, and no domestically-generated inflation to speak of, the last thing its economy needs is to make credit more costly. Rather, the weak yen is a chance to stimulate exports — even if Japan is no longer the currency-sensitive export machine it once was — and get inflation closer to the BoJ’s 2 per cent target. “A weak yen is positive for Japan’s economy as a whole,” Kuroda argued. In this, he is correct.
The rest of the world used to worry about cheap Japanese exports. If the fall in the yen now makes Japanese exports cheaper, then it will be exporting deflation: which is exactly what an inflation-hit US wants right now. A weak Japanese currency therefore suits economies on both sides of the Pacific. The BoJ should stay the course and let the yen slide.
Source: Economy - ft.com
