The Japanese yen has fallen nearly 12% against the US dollar since the beginning of 2022 to its lowest level in twenty years to trade around 128.70. It also fell 7% against the euro, 7% against sterling, 15% against the Australian dollar, 12% against the New Zealand dollar, and 11% against the Canadian dollar, making the yen the worst-performing currency in the G-10 currency of this year, but before finding out the economic reasons behind this massive decline in the yen value, let’s take a quick look on the Japanese economy which has a special nature.
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After Japan’s real estate and stock market bubble burst in the early 1990s, companies focused on cutting debt and shifting manufacturing overseas. Wages stagnated, and consumers reined in spending. That led to two lost decades with no nominal growth in the economy. Prices of goods such as fresh food kept falling, creating deflation that sapped optimism. Japan’s devastating earthquake, tsunami, and nuclear meltdown in 2011 didn’t help, which Haruhiko Kuroda, the current Governor of the Bank of Japan (BOJ), describes as a “deflationary mindset” among consumers and companies in Japan. The nation’s aging and shrinking population are now making matters worse. The challenge of growing the economy with an aging population has vexed a series of prime ministers.
The BOJ agreed with the government to set its inflation target at 2% in January 2013, less than a month after Prime Minister Shinzo Abe came to power with a plan to revitalize a moribund economy. In Japan and many other developed countries prices rising by 2% a year is seen as optimal for encouraging companies to invest and consumers to spend. It’s also thought to be low enough to avoid the risk of sparking runaway inflation.
The BOJ embarked on an asset-purchase program of unprecedented scale, eventually increasing the amount of money in Japan at a rate of about 80 trillion yen ($735 billion) a year. It now owns about 43% of outstanding Japanese government bonds. The central bank also introduced negative interest rates in early 2016, charging financial institutions 0.1% on a portion of the funds they parked at the bank to encourage them to put the money to more productive work, for instance, lending to businesses. The pace of asset purchases had slowed since 2016 when Kuroda shifted the central bank’s monetary policy focus to yield-curve control or adjusting the purchases to achieve targets for government bond yields.
As inflation surges, Japanese government bonds haven’t been immune from the global rout. Yields have climbed from a very low base to touch the BOJ's ceiling. (Japan’s yield curve control policy aims to keep 10-year government bond yields around zero with 25 basis points of wiggle room.) To cap the rise, the central bank stepped in twice offering to buy an unlimited number of bonds at a fixed rate. Bank of Japan set a four-day long unlimited buying spree of government bonds to stop the 10-year yield from rising above 0.25%. The move sent the Yen plummeting to its lowest since 2015. In three days, it had bought a combined 2.9 trillion Yen ($23.7 billion) of bonds. As long as BOJ continues with its super-easy monetary policy and yield-curve control while other central banks are turning more hawkish about the embedded inflationary pressures, the Yen is likely to suffer.
Prime Minister Fumio Kishida’s government is stepping in with a stimulus package to alleviate the burden on households. The Sankei newspaper last week put the package at more than 10 trillion Yen ($800 billion). That will alleviate some short-term strains, but it won't prevent the Yen from weakening nor reduce Japan's dependence on imported oil, which has left it very vulnerable in the wake of Russia's invasion of Ukraine. All these easing policies taken by both the Central Bank of Japan and the Japanese government, which contradict the direction of all central banks that are now tightening to control inflation, may lead to a further decline in the Yen. A consensus is building among Tokyo market watchers that the Yen can extend losses to the 130 per dollar level in the coming months.
The divergence in policies between the bank of Japan and the Fed encourages investors to sell Japanese bonds and buy U.S. bonds due to higher yields on U.S. bonds, which leads to a further decline in the yen.
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While BOJ Governor Haruhiko Kuroda has said, he’s not bothered by a weaker yen. Historically, Japan has welcomed a weakening of the Yen as it helps exporters when they repatriate profits made overseas. In the past decade, former Prime Minister Shinzo Abe ushered in a period of a much weaker Yen primarily to the applause of the business world, but the mood is shifting now though given that costs for commodities and other inputs are rising at the fastest pace in four decades. A sharply weaker Yen amplifies that pain. The average household is also feeling the bite from higher prices for imports from energy to food. With the central bank unlikely to budge, Prime Minister Fumio Kishida is left trying to temper the impact through government spending, such as fuel subsidies.
According to Tokyo Reuters Survey, more than three-quarters of Japanese firms say the yen has declined to the point of being detrimental to their business, a Reuters poll found, with almost half of companies expecting a hit to earnings. The results of the Reuters Corporate Survey are one of the most evident signs yet that much of Japan Inc is struggling with higher costs and worsening consumer demand caused by the yen's weakness. Forty-five percent of companies said they find it hard to cope with the currency weakening beyond 120 Yen, while 31% described 125 yen as their pain threshold. Overall, 48% of firms expect the currency's weakness to hit earnings, with 36% saying it would hurt profits "somewhat" and 12% saying the impact would be considerable. Some 23% said it would be a boost to profits, while 30% said it would have no impact. This month's survey was conducted between March 30 and April 8, when the Yen moved between 122 and 124 to the dollar. It polled about 500 large and midsize Japanese non-financial firms, of which around half responded.
The chart below shows the performance of the Nikkei 225 which declined around 5% from the start of 2022. It outperforms SP500, Nasdaq100, Shanghai index, and German Dax, but it only underperforms Dow Jones industrial Index and Euro Stoxx600
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