The Yen’s Volatile Journey: Key Drivers Behind the Roller-coaster Ride in 2024

A major event took place in the global markets last week with Japan’s Bank of Japan hiking up its interest rates and significantly changed the value of the yen.

The overall downward pressure on the Japanese yen has been a persistent one over the past several years or so, all related to the difference in interest rates versus the U.S. From 2022, it has lost more than 20% of its value against the U.S. dollar.

This sparked the Japanese government to intervene several times, most notably in September and October of 2022 followed by more interventions in April and May 2024 when the yen fell to a 38year low against the dollar at 161.96 in early July 2024.

The most recent suspected intervention occurred in midJuly 2024.

The fortunes of the yen shifted with the Bank of Japan’s decision to hike interest rates to 0.25% on July 31, 2024. It marked a move away from its longtime ultraloose monetary policy and jolted markets globally.

Investors, who had been borrowing yen at low rates to invest in higher yielding assets, known as carry trades, saw themselves forced into unwinding these positions, leading to a sharp rebound in the value of the yen against the dollar.

Yet, even after the rebound, the yen remains relatively weak against historical standards.

The increased interest rate actions of the BoJ did not end in the currency markets. On August 5, 2024, Japan’s stocks fell the most since Black Monday in 1987. The selling was primarily precipitated by fears over the global economy but also by the reversal of investments funded with yen.

 Historical Background of Japan’s Yen Intervention

Historically, Japan also has intervened in currency markets in an attempt to keep the yen from rising too high, as a high yen makes Japan’s export-based economy suffer.

However, since 2022, Tokyo has shifted its policy attention to yen value defense, for the latter depreciated sharply against the greenback amid the growing interstate differential between Japan and the U.S.

As was the case with most of the other central banks, it is the BoJ that has stuck out by continuing to pursue ultraloose policies in 2022 while the yen has tumbled.

The yen had both April and May 2024 defense from Japan, but with these efforts failing, the decline continued. For July 2024, market participants estimate that Japanese officials probably intervened once again.

That is because, usually, Japanese officials, like those at the Ministry of Finance and the Bank of Japan, publicly deny their intervention but would justify intervening if required.

 Reasons for the Yen’s Weakness

Several important things have contributed to the sharp depreciation of the yen in recent years:

1. U.S Japan Interest Rate Differential: The rapid pace of interest rate increases by the Federal Reserve was at odds with the still relatively very slow normalization of policy on the part of the BoJ.

At the same time, the relevant interest rates in the United States have been much higher in comparison with Japan and thus have proved more favorable for the dollar.

2. Higher Import Costs: Japan now relies more than ever on imported fuel and raw materials. This automatically makes Japanese firms have to exchange their yen for other foreign currencies to offset importrelated expenses, which also circulated to dethrone the yen.

3. Foreign Production: Most big Japanese firms diversified and began manufacturing abroad and reinvested elsewhere, hence a reduced demand for the yen in their transactions.

 Consequences of a Lower Yen on Japan’s Economy

Conversely, a weak yen is very destructive to Japan as it continues to lift the overseas yen denominated profits.

On the other hand, a lower currency increases import costs on fuel and raw materials, thus translating to higher selling prices for retailers and consumers.

It can be represented through Japan’s core inflation rate, which has been running above the BoJ’s 2% target for 27 consecutive months.

The higher inflation meant that the already strained purchasing power of living costs for the households was being eroded further with the weak yen.

In addition, with a weak yen, the gains Japanese exporters are experiencing are not as high now as they have been some time since because many Japanese manufacturers have shifted their lines overseas.

 Future Prospects: Will the BoJ Hike Rates Again?

Analysts are now waiting for signals about future policy moves by the BoJ in light of the rate hike implemented this July.

The BoJ, according to Governor Kazuo Ueda, is quite open to further rate hikes if Japan will continue to work toward its 2% inflation target. Some analysts expect the BoJ to raise its rates eventually up to a level where it will be neutral for the economy of Japan, that is about 11.5%.

However, in doing so, the BoJ will act very cautiously not to undo the still fragile efforts there are to revive Japan’s economy.

The Economic Risks of Another Round of Rate Hikes

While higher interest rates may strengthen the yen and help alleviate inflationary pressures, it is not without some risk. Japan’s public debt is already the largest in the world; high interest rates will drive up the government’s borrowing cost.

More importantly, aggressive rate hikes might weigh on domestic consumption, which remains relatively weak.

 Conclusion

For example, the BoJ is still expected to raise interest rates this quarter, which would mark a significant policy shift from what Japan has been coming under so far. Both inflation and yen concerns are also getting stronger.

Still, it is all a delicate balancing act for Japan. Hitting the economy too hard could as easily strangle its potential for growth, while low rates might even weaken the already falling yen and fuel inflationary pressures.

How Japan navigates around these problems will have a great deal to do with not only the way global markets look but also to the structure of its economic recovery.