Causes of the weakening yen and its consequences

Movement of the yen against the US dollar is influenced by complex interplay of factors from interest rate differentials to economic performances, monetary policies, market sentiments, amongst others.

Over the past two years, the yen versus the US dollar has been steadily weakening.

What has affected the price of yen versus the US dollar?

1. Higher energy prices: Beginning in 2021, as energy prices rose, Japan, which imports 98% of its crude oil and most of its natural gas and coal, would be adversely affected by the soaring costs. In comparison, the US, a major exporter of natural gas, would see comparatively less impact of higher energy prices. This increases the cost of electricity in Japan which also leads to higher costs of manufacturing and higher costs of exports.
2. Interest rate differentials: The higher interest rates in the US set by the Federal Reserves compared to Japan’s Bank of Japan can attract investors seeking higher returns. This increased demand for US dollars can lead to a relative strengthening of the US dollar against the yen. Over the past two years, as the Fed has been consecutively hiking its interest rates to curb inflation. In April 2023, Japan’s inflation rate hit 3.4%, above the Bank of Japan’s target of 2%.
   the Bank of Japan, by contrast,
3. Comparative economic performance: The US economy’s better performance relative to the Japanese economy’s can lead to a stronger US dollar. Japan has been seeing a weak GDP, at 2.2% in 2021 and 1% at 2022. In comparison, US’s GDP grew at 5.9% in 2021 and over 2.1% in 2022.
4. Market sentiment and risk appetites: The exchange rate between the yen and the US dollar can also be influenced by broader market sentiment and risk appetite. During times of uncertainty or risk aversion, investors may seek safe-haven assets leading to its appreciation. Conversely, if market participants exhibit increased risk appetite, they may move away from safe-haven currencies, causing it to weaken.

Economic growth in Japan remains weak with GDP growth at 2.2% in 2021 and 1% in 2022.

Consequences of a weakening yen

1. Rising costs for Japanese importers: A weaker currency relative to the US dollar can also be crippling for the Japanese economy that relies heavily on imports. A weak yen can make imported goods more expensive for Japanese consumers and businesses. Imported products, such as foreign electronics, automobiles, or luxury goods, may see price increases due to the currency exchange rate. This can lead to higher costs for import-dependent industries and potentially impact consumer purchasing power.
2. Japanese consumers and citizens traveling abroad: A weak yen can lead to higher import prices, particularly for goods and commodities that are not produced domestically. This can contribute to inflationary pressures, potentially affecting the purchasing power of Japanese consumers. A weak yen also means that Japanese travelers need to spend more yen to convert into foreign currencies when traveling abroad. This can make international travel more expensive for Japanese citizens and reduce their purchasing power during trips.
3. Attracting foreign talent: While a weak currency may welcome tourists who can see their purchasing power increase relative to a weakening yen, it may deter foreigners from working in Japan if it translates to lower value of wages. This can make it difficult for the government or Japanese corporations to attract foreign talent to work in Japan and receive Japanese yen as compensation.

Interventions to strengthen the yen against the US dollar

1. Bank of Japan’s interventions: In September 2022, for the first time in 24 years, Japan intervened to buy the yen for dollars, spending 2.84 trillion yen ($19.5 billion) to mitigate the yen’s sharp fall versus the dollar. On 21 October 2022, Japan spent a record 5.62 trillion yen ($42.5 billion) on a single day yen-buying intervention and additional 730 billion yen on 24 October 2023.
2. Reopening of Japan’s economy to tourists post-pandemic: With the country’s reopening, spending by tourists keen to take advantage of the weak yen could increase the demand for yen and strengthen the position of yen relative to while Japan was in lockdown. The government anticipates that tourists will spend an estimate of 5 trillion yen ($34 billion) over the next financial year.

Statement by the Bank of Japan on 16 June 2023

Like the US and Europe, Japan is also facing a high inflation rate at 3.5% in April 2023, above its target of 2%. To curb its high inflation rates, the European Central Bank raised borrowing costs to a 22-year high on Thursday, while similarly, the US Federal Reserve held interest rates steady at a high of 5.24% on Wednesday.

The Bank of Japan, in contrast, announced on Friday, 16 June 2023, that it will maintain its -0.1% short-term interest rate target under its yield curve control policy.

Negative interest rates are an unconventional monetary policy tool that the Bank of Japan has used to stimulate its economy. As part of this policy, commercial banks are subject to a negative interest rate of -0.1% on any surplus reserves they hold at the central bank.

While encouraging banks to lend money to businesses and households, hence stimulating the economy, one of the most significant impact of the negative interest rates was the yen depreciation. With the announcement, the yen fell, hitting a new 15-year low of 153.9 per euro and falling 0.25% at 140.6 to the US dollar.

According to the Bank of Japan, it expects inflation to decrease and become more moderate around the middle of the current fiscal year, which ends in March 2024. This anticipated moderation in inflation is attributed to the decline in fuel prices and global commodity prices.