Yen’s Plunge Halted for Now After Hitting a 40-Year Low: Here’s What’s Behind the Currency Intervention

Following its recent 40-year low, the Japanese yen has stabilised for the time being thanks to intervention by Japan and the US in the foreign exchange market. In July, the yen had at times fallen to an exchange rate of around 164 yen to the dollar, its lowest level since the 1980s. Following a coordinated move by Japan and the US in the foreign exchange market, the yen strengthened, whilst the dollar fell below the 160-yen mark. Most recently, the yen has stabilised near these levels.

Japan has been battling against the depreciation of its currency for some time. The weak yen is driving up import prices and thereby fuelling inflation, which in turn is weighing on consumer confidence. Added to this are the rising oil prices resulting from the war in Iran: due to the weak yen, oil, being inherently expensive, is becoming even more costly for Japan’s economy with its heavy reliance on oil imports.

Yen suffers from hesitant approach to interest rate moves and doubts over fiscal policy

The background to the yen’s weakness is that many market participants view the Bank of Japan’s actions as too hesitant. The Bank of Japan has, however, now moved away from its zero-interest-rate policy and most recently raised its key interest rate from 0.75 to 1.0 per cent in June. This makes it the highest interest rate in 31 years.

In doing so, the central bankers have responded to the price pressures resulting from the war in Iran. However, many experts would like to see the Bank of Japan take more decisive and swift action in the fight against inflation. For example, at its last meeting in July, the central bank left interest rates unchanged.

In the foreign exchange market, the yen’s losses are also seen as reflecting doubts about the fiscal policy of Japan’s new Prime Minister, Sanae Takaichi. Despite high levels of debt, the Prime Minister intends to stimulate the economy through expansionary government spending. However, this is also fuelling concerns about the country’s financial stability.

Back in the spring, Japan had already taken several drastic measures to combat the yen’s weakness. According to data from the Ministry of Finance in Tokyo, the government intervened in the market on a total of three days between 30 April and 6 May. On 30 April alone, it sold the equivalent of 6.28 trillion yen in dollars, with just under 40 billion dollars. However, despite these record interventions, the yen’s slide could not be halted.

First joint foreign exchange market intervention with the US in 15 years

In early August, Japan finally took joint action with the US to counter the yen’s weakness as part of a concerted foreign exchange market intervention. This marks the first combined intervention by the two countries in 15 years. Back then, they had cooperated to weaken the yen following the earthquake in eastern Japan.

According to data from the Bank of Japan, Japan is thought to have sold several billion dollars against the yen this time to prop up the currency. The US, on the other hand, sold euro holdings rather than US dollars to support the Japanese currency. This was reported by the “Financial Times” newspaper and the Reuters news agency, citing foreign exchange traders. Experts believe that, with this unusual move, the US government wanted to avoid giving the impression of seeking to devalue the dollar. A weaker dollar would fuel inflation in the US, which is already above the Federal Reserve’s target.

US President Donald Trump confirmed US support for the Japanese currency and described it as a sign of friendship. “They have a weakening yen, and they wanted a little bit of help. And we’re always there for Japan,” Trump said in response to a reporter’s question.

The US also stood to gain from the agreement. With holdings of 1.14 trillion dollars, Japan is the US’s largest foreign creditor. By utilising a so-called facility, Tokyo can secure dollar liquidity without having to sell its US Treasury bonds directly, which would drive up yields on the US bond market. According to experts, the move underlined both countries’ determination to prevent the global repercussions of a sell-off of the yen and Japanese government bonds. “We are in close contact with the US Treasury and will not hesitate to carry out further joint interventions,” Japan’s Ministry of Finance stated. US Treasury Secretary Scott Bessent said that Washington also wished to participate in further joint interventions. He expressed his support for Japan’s decisive steps to correct the currency’s significant undervaluation.

For Erste AM Chief Economist Gerhard Winzer, however, a sustained reversal in the yen’s trend remains difficult to imagine as long as monetary and fiscal policy in Japan remain expansionary. “Interventions can slow the depreciation, but they can hardly eliminate the fundamental causes of the currency’s weakness,” he comments. At the very least, Prime Minister Takaichi’s policy of expansive government spending would have to be offset by a restrictive monetary policy from the Bank of Japan. According to Winzer, this would require a key interest rate significantly above the current inflation rate of 1.7% – the current key interest rate, however, stands at 1 percent, well below that level.

 

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