Japan's Interest Rate Rise

Japan has experienced near-zero interest rates for over two decades due to aggressive monetary easing policies. However, inflation has recently emerged in Japan, with consumer prices rising 2.6% year-over-year in March. Bank of Japan (BOJ) announced to raise interest rates to 0.1% in March. The date of raising interest rate is earlier than Wall Street market expectation (April).

Japanese Yen Depreciation ?

Theoretically, raising interest rates should lead to yen appreciation, but the yen has continued depreciating against the US dollar. Why ?

• Conservative Approach by the Bank of Japan (BOJ): The BOJ’s cautious stance on raising interest rates stems from concerns that a sudden and significant increase could negatively impact the Japanese economy. By opting for a conservative 0.1% increase, the BOJ fell short of Wall Street’s expectations. This discrepancy between market expectations and the actual rate hike has led to a “buy the rumor, sell the fact” situation.
• Influence of the US Federal Reserve (Fed): Fed remain more relevant for USD/JPY than BOJ. Depreciation accelerate as US March CPI print with strong USD. After the CPI print, the market expectation for the Fed cut decelerated further. There is high correlation between USDJPY and Fed Fund Future (2025>2027>2026). The highest correlations is 2025 FF future suggested that the market main focus is the timing of the first rate cut and the extent of the rate cuts in this year.
  • Interest Rate Gap between the US and Japan: The higher interest rates in the US maintain a significant interest rate gap between the US and Japan. This gap enables traders to engage in carry trade strategies, where they short the yen and go long on the US dollar or purchase US assets.

Given these dynamics, various scenarios can affect the USD/JPY exchange rate:

Cooler Inflation ?

With the latest CPI data release, consumer prices (exclude fresh food) rose 2.6% in March ( 2.8% in February ), slight decrease compare to the February data.

• Nonperishable foods prices climbed 4.6%, slowing from February’s 5.3% gain.
• Hotel room rates rose 27.7%, down from a 33.3% jump the previous month.
• Utility bills fell 1.7%, with gas prices down by 7.1%.

However, the depreciation of the yen raises concerns about cost-push inflation. Japan heavily relies on imports of natural resources such as oil and gas, and increased import prices could raise overall production costs, further driving up product prices. Japanese consumers have tightened their budgets, with household spending decreasing for 12 consecutive months as price hikes continue to outpace wage gains. Additionally, the termination of government utility subsidies from May is expected to contribute to inflationary pressures.

Currency Intervention vs BOJ hike interest rate

As Last Wednesday, the USDJPY reach the lowest point since 1990. Top financial official have been sending warning and have hinted that they would be ready to step in. However, until now, there is still no sign for the government intervention.

• Firstly, MoF (Ministry of Finance) do intervention on Yen should comply with the G7 commitment on FX.

  G-7 statement stated “exchange rates should be determined by the market, reflecting fundamentals” and “excessive exchange rate volatility is undesirable because it can have adverse effects on economic and financial stability”

• Secondly, there is no “line in the sand” level for FX intervention as officials clearly stated repeatedly. In other words, the speed of changes in JPY FX rate is more important than the specific value. Last time intervention is in 2022 Oct, at that time, the “USD/JPY changed by about 25% in just over six months from March,” and “The historical volatility of the USD/JPY has more than doubled over the past month”. But however, this time, recent move in USDJPY is more modest than that seen in 2022.

Furthermore, is it effective to conduct currency intervention at this time ? If intervention were to stabilize the currency back to 149, it is likely that the yen would quickly return to 155 in the short term due to the strong US dollar and US interest rates. Instead, more effective solutions could involve cutting the Fed rate or the BOJ launching additional rate hikes, which could drive the yen higher.

Reference

• Key Currency Views from JP Morgan (issued at 12 April 2024)

• Why hasn’t Japan moved to prop up the weak yen?

• Japan’s Inflation Cools Ahead of BOJ Policy Board Meeting

finance — Apr 21, 2024