Throughout the past year, the Japanese yen has depreciated by almost 20%. The yen is now trading at a historic 25-year low. Despite the steep drop, the yen remains a key foreign exchange reserve for Japan. And the Bank of Japan (BoJ) has resolutely maintained its ultra-loose monetary policy.
The yen’s decline is particularly painful for Japanese households and businesses. The yen’s depreciation has led to higher costs for imported goods such as food and energy. Wage gains have sunk and more workers are being brought in from other countries. This has increased the pressure on corporate margins, which are squeezed by rising import costs. It has also weakened support for Prime Minister Fumio Kishida, whose public support was eroded by the yen’s slide.
The yen’s fall has raised questions about the long-term policy direction of the BOJ. Although the BOJ has repeatedly stated that it would keep its yield cap on Japan’s 10-year government bonds at 0.25%, analysts have doubted whether the action would be enough to stop the yen’s slide. The yen’s steep fall has also prompted speculation about the likelihood of a rate hike. The BOJ has ruled out a rate hike for the near future. The next FOMC policy meeting is scheduled for December 13-14.
In the short-term, the USD/JPY pair is range-bound. The pair has been confined to a Descending Triangle pattern, which implies that it will either move in the bullish or bearish direction. However, the direction of the trade depends on the risk sentiment of the broader market. If the Fed increases rates, the gap between the US and Japan will widen. In addition, the impact of the Russian invasion of Ukraine will be felt in the Japanese economy.
The yen has been in a downward trend since October 2021. In that month, the 10-year JGB yields reached the upper limit of the BOJ’s YCC. While the BoJ is expected to defend its YCC, inflation has accelerated beyond the target of 2%. It expects inflation to slip below the target in April of 2023. If prices continue to rise, consumption will be weaker than it was in recent years. In addition, the Japanese government plans to restart idle nuclear plants. The yen’s weakness will hit consumer spending, which is already in recession.
A strong currency makes exports more attractive and supports large Japanese firms in their global operations. It also helps to boost the value of repatriated overseas profits. Increasing import costs will also pressure corporate margins, which are currently squeezed by a shrinking population. It is unlikely that the yen will reverse its course until the United States recovers from a recession.
The Bank of Japan is defending its monetary policy, but is stepping up its efforts to cement inflation in the minds of consumers and businesses. The BOJ has ruled out yen-buying intervention in the currency market, and it has also ruled out a rate hike in the near-term. And the Japanese government is boosting its domestic spending to support its monetary policies.