Weak Japanese Yen Creates a Dilemma for the Bank of Japan

It has been steadily sliding for more than three years. By the summer of 2024, the Japanese yen had a value against the US dollar that was almost a third lower than it was in early 2021. 

This marked depreciation has occurred despite a concerted effort by the Bank of Japan, often referred to as the BOJ, to prop it up. The bank spent nearly ¥10 trillion JPY - around $62 billion USD - to boost the yen during the spring of 2024. That expensive process has had little long-term impact.

Masamichi Adachi, an economist at UBS in Tokyo, maintains that the only way for the central bank to give the yen a real boost is to raise interest rates significantly. That means raising rates perhaps by more than a percentage point this year, in 2024.

He notes that the BOJ continues to keep rates at an "extraordinarily low" level, even as they rise in other countries. It finally raised them in March - the first hike in 17 years - but only to just over 0%.

Mr Adachi believes there's a strong case for higher rates. However, he also believes such a move is "unsustainable" due to weak domestic demand and higher living costs.

"It's a huge dilemma," Mr Adachi told the Financial Times.

Inflation Issues

Central banks assess many issues when it comes to setting rates. A crucial factor is how fast prices are rising.

For the past two years, inflation has remained close to the BOJ's 2% target. However, many imported goods have gone up more in price. Fresh food has become significantly more expensive and as a result, many people have cut back on their spending.

The weak yen also makes foreign holidays less attractive for many Japanese people. At the same time, it draws millions of foreign visitors to Japan, boosting tourism.

Furthermore, there are signs that inflation may increase in the coming months due to rising oil prices.

This will worry small business owners, who employ seven out of ten workers in Japan. They have little space to raise their prices in a competitive market. 

For larger companies, especially Japan's export-focused multinationals, a weak yen has advantages. It means the money they earn abroad is worth more when brought home, helping their profitability.

When Is It 'Too Weak'?

However, a weak yen pushes up the cost of buying raw materials and components. With this in mind, Masakazu Tokura, the chairman of the powerful Keidanren business lobby group, has concluded that "the yen is a little too weak." 

The Bank of Japan also takes into account changes in how much people are earning. 

In the spring of this year, on the advice of the government and the Keidanren, major Japanese companies agreed to increase wages by 5.2 percent. It is the biggest increase since 1991. This is welcome news for people on regular salaries. However, those in part-time jobs, or on short contracts, are unlikely to benefit much. In fact, they may experience a further decline in the real value of their incomes.

Investment Alternatives

The debate about the yen's value has filled much airtime on Japanese TV. Pundits are often asked to explain why the currency's value has declined during a sustained rally in the stock market. The usual answer is that investors tend to turn to shares when the yen looks weak, as they seem an attractive alternative. 

This may partly explain why the Nikkei stock average hit an all-time closing high, rising 332.89 to 40,913.69 points on July 4. Meanwhile, the local Topix index has been one of the world's top performers with a 15% gain in 2024. 

Shuji Hosoi from Daiwa Securities believes "the effect of the weak yen, specifically the increase in the profits of foreign-demand companies will remain." He also predicts that "domestic demand, which was sluggish in the first half of the year, will pick up in the second half." 

Other factors are also driving the stock markets higher. These include optimism that Japanese companies are well-placed to profit from rapid advancements in artificial intelligence technology. In America, excitement about this sector has helped push the S&P 500 index and the tech-heavy Nasdaq to record highs.

American Action

Rates have been booming in America, and are now more than five percentage points higher than they are in Japan. This has an effect on many areas of finance. A ten-year Japanese government bond yields just 0.9%, compared with 4.6% for an American Treasury of the same maturity.

With this in mind, the Economist magazine recently ran an editorial warning that the process of using foreign reserves to prop up the yen is costly and futile. 

"There is no doubting Japan's firepower: at last count, it had almost $1.3 trillion of foreign exchange reserves to run down. But it is a waste to spend them doing battle with currency traders who - thanks to the choices of Japan's own policymakers not to follow the Fed - have good reasons to be selling yen and buying dollars," said the magazine.

Prime Minister's Problems

The weakness of the yen is one of a number of issues that appear to be undermining public confidence in Prime Minister Fumio Kishida. An opinion poll taken by Kyodo News in June put Mr Kishida's personal approval rating at a mere 21 percent. Some members of his own party are calling for him to step down.

Meanwhile, Finance Minister Shunichi Suzuki has promised to "closely monitor the foreign exchange markets with vigilance." Mr Suzuki has pledged to take action on "excessive currency volatility" and to press the Bank of Japan to prove that intervention is actually effective. 

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Author: Duncan Bartlett, Diplomatic Correspondent
Mr Bartlett is the Diplomatic Correspondent for JAPAN Forward and a Research Associate at the SOAS China Institute. Read his other articles and essays.