Yen Pays the Price for Diffident Bank of Japan

Japan’s Prime Minister is insisting that after giving some preliminary advice to the Bank of Japan, he is getting out of the interest rates business. Shigeru Ishiba suggests that the central bank can do whatever it wants. The problem is that the BOJ doesn’t know exactly what it wants – and the yen is paying the price.

After a surprise rally in the third quarter, Japan’s currency is retreating again: It is down about 4% against the dollar this month and getting closer to the level where the government stepped in earlier this year to halt its decline. Intervened in the markets. Traders are speculating when the Finance Ministry will become an active buyer again, and if not. As I wrote in September, the worst was believed to be behind the yen.

It’s worth considering why, in addition to several carefully timed purchases by the state, the yen got such a boost, and whether those factors still have the same potential today. The currency’s strength in July to September hinged on two factors: surprise aggression from local monetary authorities and the Federal Reserve’s pivot to rate cuts. While most economists predict further withdrawal of stimulus from the BOJ, Governor Kazuo Ueda and fellow policymakers have recently emphasized a do-it-slow approach. The new tone could represent a significant change rather than another communication glitch of the kind that plagued the bank in the Ueda era.

For the BOJ, it’s more about what isn’t said. The surprise increase on July 31 was accompanied by a plan to reduce bond purchases as well as some aggressive forward guidance. Japan’s economy did not need to exceed forecasts for additional tightening, it simply had to perform as officials expected. Given that there is a large difference in borrowing costs between Japan and elsewhere, particularly the US, this was a recipe for considerable yen strength.

So when Ueda abandoned prior guidance at the following monetary conference in September, it was notable. The governor then suggested that the litmus test for additional growth would include the health of the global economy, primarily the US. Although this is a fair thing to say, it seemed as if Ueda was getting cold feet. If yes, why? The yen is a good place to look: It’s coming off a good few months in a good position compared to July, when it hit 160 per dollar, the weakest level in a generation.

Since Ueda became BOJ chief in early 2023, there have been several instances when his rhetoric has evolved along with the yen. One such occasion was in May, when he left a meeting with then-Prime Minister Fumio Kishida after talking tough about the impact of the exchange rate on inflation. We are aware that since the 1990s inflation targeting, often with somewhere around 2%, has become fashionable around the world. But what about currency targeting? That is very rare. Although Ueda and company will be angry at the tag, their actions leave them open to recrimination.

Dollar strength is playing a role. The greenback has advanced against the euro, British pound and Canadian dollar as bets for more major interest rate cuts in November have faded. It’s important to keep some of this in perspective: The US economy appears to be resilient, but inflation is falling rapidly. Additional cuts are coming, but will likely be quarter-point increases, with no crisis in the general size of the adjustment, rather than a half-point move like in September.

And what about interference? The beauty of the government’s yen purchases in April and July is that the MOF chose its shots. The ministry did not announce its moves, and sometimes waited for the market to move in the right direction before joining the fray to provide an additional boost to the yen. After falling out of favor over the past few decades, intervention has returned as a legitimate tool. It would be unrealistic to think that Japan will not show its hand in the markets again.

Ultimately, the yen discussion comes back to the question of rates. While the Fed is first among peers and has historically set the pace globally, local dynamics matter. Ueda can tell Washington whatever he wants, but his inability to settle on a coherent message is part of his country’s currency problem. The BOJ probably wants to tighten again and bring the key rate closer to 1% in several steps – it is now only 0.25%. I wish Ueda could say this out loud and not be so scared.

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Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor for economics at Bloomberg News.

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