As Bank of Japan diverges from peers, yen weakness provides tolerance test

The yen’s value may slide further, testing the tolerance of price-sensitive consumers — and Japanese policymakers.

The biggest driver would be the divergence between the U.S. Federal Reserve, which has apparently entered a rate hike cycle, and a dovish Bank of Japan with continued commitment to keeping powerful monetary easing for an extended period.

Surging crude oil and commodity prices in the aftermath of Russia’s invasion of Ukraine have pointed to the worsening of the current account balance of resource-poor Japan, supporting yen weakness.

More broadly, the prospect of yen depreciation underlines the fragility of the world’s third-largest economy with low growth potential, analysts say.

“The yen is currently facing a perfect storm,” said Martin Schulz, chief policy economist at Fujitsu Ltd.

The divergence of monetary policies among the BOJ, the Fed and the European Central Bank has added to the momentum for yen weakness, with the U.S. dollar in particular gaining from “its show of strength during global financial sanctions against Russia,” Schulz said.

The dollar has hit a six-year high above ¥119 after the Fed’s first rate hike decision since 2018. Market watchers say the psychologically important ¥120 line is in sight before what is perceived as BOJ Gov. Haruhiko Kuroda’s defense line of ¥125.

“The Finance Ministry and the BOJ cannot defend the yen against depreciation when demand is (also) driven by geopolitical trends,” Schulz said, adding that a further slide in the yen is possible.

A weaker yen, however, would deal a blow to consumers who are sensitive to price hikes as a growing number of companies have already been passing on higher energy and raw material costs.

It would also become a sensitive issue for Prime Minister Fumio Kishida in the lead up to this summer’s Upper House election, as ruling party lawmakers are ramping up their calls for additional stimulus to help households hit by higher energy, food and other prices amid uncertainty about the war in Ukraine.

Price hikes are good news for the BOJ as long as they are accompanied by strong wage growth so consumer demand will not be hurt.

Commodity inflation is a mixed bag as core consumer inflation looks headed toward the BOJ’s 2% target but as the governor has said the sustainability of such upward momentum is in question, bolstering the case for no change in monetary policy.

So far, Kishida has not taken aim at the yen’s weakness pushing up import costs, saying that surging commodity prices are more to blame.

The Fed is scrambling to tame inflation projected at 4.3% this year with six more rate hikes seen as likely. Japan’s consumer inflation has been picking up, but at a much slower pace. The core consumer price index excluding volatile fresh food items rose 0.6% in February from a year earlier.

“For the United States, a strong dollar is favorable when the biggest challenge is to curb inflation. For Japan, a weak yen is good when the BOJ is aiming for the 2% target,” said Masafumi Yamamoto, chief currency strategist at Mizuho Securities Co.

Yen weakness will likely continue as the gap between U.S. and Japanese long-term interest rates widens, though the momentum may ease later this year if the pace of the Fed’s rate hikes slows in line with lower inflation, analysts say.

Facing lawmakers from the ruling Liberal Democratic Party at its recent convention, Kishida sought to assure them that he is mindful of the negative impact from rising fuel and food prices on voters.

But he emphasized that Japan is “not in a state of deflation” because of former Prime Minister Shinzo Abe’s economy-boosting program that entailed bold monetary easing by the BOJ.

“My administration will build on the results of Abenomics, try to maximize them and create a sustainable economy,” Kishida said as he called for party unity heading into the key national election, likely to be held in July.

The prime minister has expressed hope that the BOJ will continue to guide its policy with the aim of achieving the 2% target.

Kuroda said cost-push inflation will not prompt the BOJ to change its policy and powerful easing will be in place until the inflation target is achieved in a sustainable way. The central bank has been seeking to keep borrowing costs low for consumers and businesses with its “yield curve control” program.

“Inflation may accelerate toward 2% in April but it by no means will necessitate a modification of our current monetary policy,” Kuroda said Friday after a two-day policy meeting.

With a recent announcement to buy an unlimited amount of 10-year Japanese government bonds at a fixed rate, Kuroda has already made it clear that the BOJ will step in if Japan’s long-term interest rates near its upper limit allowed under the “yield curve control” program.

As the BOJ has maintained ultraeasy monetary policy, the yen’s real effective exchange rate has fallen to its lowest level in half a century, with analysts saying that reflects the relative decline of Japan’s economic power.

“Japan has failed to change into a high growth economy and the yen has weakened as a result. There are limits to what monetary policy can do to make the economy stronger,” Mizuho Securities’ Yamamoto said. “The ball is not in its court now.”