The Yen Conundrum

Key Takeaways


  • The value of the Japanese Yen (Yen) to The United States Dollar (USD) has plunged drastically over the past few months, to a 20-year low, due to interest rate differentials between Japan and the United States of America (USA).[1]
  • Despite Japan’s high dependence on the import of natural resources, the Bank of Japan (BOJ) is set to maintain ultra-low interest rates and to commit to its yield curve control policies.[2]
  • If the BOJ does not detract from its position, the Yen is likely to continue falling[3], increasing costs of imported inputs for companies and costs of living for Japanese residents driven by higher prices for food and commodities. However, this could be beneficial to the Japanese economy in the long term.


Over the past few months, the Yen to USD exchange rate has plunged by more than 10%. As of 20 May 2022, the Yen is trading around a 20 year low of 128 Yen per USD. A key reason for the drop is the interest rate differential between Japan and the US. The US, as well as many other nations, has been raising interest rates to curb inflationary pressures. The BOJ however has committed to its yield curve control policy, maintaining ultra-low interest rates.[4]

The increasing interest rate differential between the 10-year US government bond and Japan has led to an outflow of funds from Yen to USD.

At first glance, the devaluation of the Yen appears to be largely beneficial to the export reliant Japanese economy[5], with exports making up 17.4% of its GDP in 2019.[6] The cheaper Japanese exports as a result of the devalued Yen would increase the competitiveness of its exports and Japanese firms would be able to export increased volumes of goods and generate higher revenues.

However, Japan is also highly dependent on the import of resources such as petroleum, integrated circuits and computers.[7] Many Japanese firms reliant on imports are now grappling with higher costs of production[8] due to the plunging Yen value as well as the Russia-Ukraine conflict. The volatile currency movements also make it challenging for Japanese firms to anticipate revenues and costs of inputs and this in turn makes it difficult for firms to plan for future business activities.

The rising costs of inputs have led to greater energy and food costs for the average Japanese consumer, with real incomes being pushed down.[9]

Despite the negative impact that the plunging Yen has on the economy, the BOJ is persisting in its commitment to the yield curve control. The Bank of Japan Act Chapter 1 Article 2 states that the Bank’s monetary policy should be “aimed at achieving price stability, thereby contributing to the sound development of the national economy.” On that basis, the BOJ has set a 2% CPI target.[10] In other words, the BOJ’s focus is on inflation, which remains at less than 2%[11], as opposed to exchange rate controls.

In addition to their mandate, the BOJ is likely to maintain its yield curve control because Japan has public debt equivalent to twice the size of its economy, due to decades of fiscal spending to support its economy. An increase in interest rates would increase debt financing costs for many individuals and businesses and could be very damaging to the economy.[12]

Here is what appears to be the Yen conundrum. If the interest rate differential between Japan and the rest of the world continues growing and the BOJ continues maintaining low interest rates, the Yen will continue to depreciate, hurting Japanese firms and consumers. If the BOJ decides to increase their rates, they may be able to slow down or curb the depreciation of the Yen, but this move might have certain undesirable impacts on the economy.[13] It appears that the BOJ has a tough problem to solve.

To an extent, some argue that the BOJ may have no choice but to raise rates. The rising prices have started to affect the Japanese population and given that the Upper House elections are drawing near, there may be political pressure on the BOJ to increase rates.

In our opinion however, we do not believe that the BOJ will raise rates in the short term. Several analysts believe that the US cannot raise rates too aggressively or they might put the economy into recession.[14] The US will also not be able to raise rates indefinitely.[15] This means that the interest rate differential between the US and Japan should eventually stabilise. At that point, the value of the Yen should also stabilise. Japanese firms will no longer face such a volatile exchange rate environment and will be able to better plan their future business activities.

The increase in prices of goods and services will also help the Japanese economy reach a higher inflation rate that the BOJ has been trying to attain. The rising prices may also spur corporate Japan to consider wage increases to cope with the rising prices. All these factors would contribute to an even higher inflation rate and might be what the BOJ needs to jolt the economy out of their deflationary mindset that dragged down economic growth.[16] In addition, it is the BOJ’s opinion that raising interest rates would be more undesirable for the economy than maintaining its current stance.


What it means for investors

In the medium to longer term, the interest rate differential between the US and Japan should stabilise. With Japan opening its borders to tourists again soon, the lower Yen can spur an increase in tourism revenue for the country. With Japan still being a very wealthy nation with large amounts of foreign assets, the Yen will eventually start to recover.

This current period of inflation in Japan could be what the Japanese people need to abandon their deflationary mindsets. This would lead to Japanese consumers and firms preferring to invest rather than to save and can lead to a boost in the Japanese economy in the long term.

In the meantime, the Yen may continue to fall further, and investors can take the chance to invest in Japan at low prices and dollar cost average if the Yen continues to drop.



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