The weakness of the Japanese yen is once again in the spotlight after its recent plunge.
On Monday, the currency fell to 160.17 against the US dollar, its lowest level since April 1990.
The yen recovered to 155.01 per dollar later in the day, prompting speculation that Japanese authorities had intervened to support the currency’s value.
The yen weakened slightly again on Tuesday, but was able to hold on to most of the previous day’s gains.
Why is the yen falling?
The value of a country’s currency rises and falls relative to other currencies according to the laws of supply and demand.
Currently, investors are being pressured to dump the yen due to the yawning interest rate gap between Japan and the United States.
While the US Federal Reserve’s key interest rate is currently 5.25 to 5.50 percent, the corresponding interest rate of the Bank of Japan (BOJ) is only 0 to 0.1 percent.
“The main reason is the interest rate difference between the US and Japan,” Min Joo Kang, senior economist for South Korea and Japan at ING, told Al Jazeera.
“In addition, market expectations regarding the Fed’s monetary policy changed quickly.”
The interest rate gap reflects the very different inflation environments in the US and Japan. While Japan is struggling to raise prices and wages after decades of economic stagnation, the United States is struggling to lower prices amid robust economic growth.
For investors, higher interest rates in the USA mean the opportunity to achieve significantly higher returns on investments, such as government bonds, in this country than in Japan.
The more investors sell the yen, the more it loses value – encouraging investors to keep selling in a self-perpetuating cycle.
Is this a new phenomenon?
Actually, it’s part of a long-standing trend.
While the yen’s decline has been particularly severe recently, the currency has been in a continuous downward trend since the beginning of 2021.
Over the past three years, the yen has lost more than a third of its value.
The currency is now back to the level it was at after a huge asset bubble burst in the early 1990s.
While other countries have raised interest rates to curb inflation that has skyrocketed during the COVID-19 pandemic, Japan has kept borrowing costs at extremely low levels to pull the economy out of a prolonged stagnation known as “the lost decades.” is known to get out.
Although the BOJ raised interest rates last month for the first time in 17 years, Asia’s second-largest economy is still an outlier globally.
Why does it matter that the yen is so weak?
A weak currency is a mixed bag for the economy.
The weakening Japanese yen has helped boost exporters’ profits by making their products cheaper for buyers abroad.
The decline has also led to a record influx of foreign tourists – 3.1 million visitors came to the country in March alone – whose spending helps support local businesses.
But the yen’s collapse has sharply increased the cost of imports, particularly food and fuel, and strained household budgets.
The benefit of a falling yen for exporters was also tempered by the fact that many large Japanese companies conduct a significant portion of their business abroad.
What can Japan do about it?
Japanese officials have repeatedly expressed concern about the yen’s excessive devaluation and indicated they are ready to intervene if necessary.
The authorities can use two main levers: buying up the yen or raising interest rates.
On Monday, the sudden rise in the value of the yen sparked speculation that authorities had intervened in foreign exchange markets to halt the decline, the first such intervention since late 2022.
Japanese authorities have not confirmed their intervention in the market and official figures indicating whether they have done so will not be available until the end of May.
Nevertheless, the momentum appears to be working against a significant appreciation of the yen in the foreseeable future.
During their intervention in 2022, Japanese authorities spent more than $60 billion of their foreign exchange reserves to support the yen – only to see it slide further.
Meanwhile, the wide gap between interest rates in Japan and elsewhere is likely to persist for some time.
While BOJ Governor Kazuo Ueda has suggested the central bank could raise interest rates if inflation rises, price growth has slowed in recent months.
On Friday, the BOJ kept interest rates steady, reinforcing expectations that its ultra-loose policies will continue.
Meanwhile, recent signals from the Federal Reserve have dampened expectations that significant interest rate cuts will be made this year as inflation remains stubborn.
ING’s Kang said she expects the yen’s weakness to continue in the coming months.
“We believe that foreign exchange interventions by the Japanese authorities can only slow down the pace of depreciation, but cannot change the direction of currency movement,” she said.
“To change the course of the yen, either the BOJ should suddenly increase its hawkish voices – we believe this is unlikely – or the Fed should give a clearer signal of rate cuts. This is not likely in the short term either.”