【MACRO Insight】Is Japanese Authorities' Intervention an Exchange Rate Stabilizer, Catalyst, or a Source of Market Tension?

Recently, the sharp fluctuations in the Japanese yen exchange rate have attracted widespread attention in the global foreign exchange market. On Wednesday, speculation about the possibility of Japanese authorities intervening again to support the yen intensified, leading to a more than 1% surge in the yen's exchange rate within a single day, reaching its highest level since June 12th. This volatility has triggered turmoil in the global foreign exchange market, with the US dollar index falling further, hitting a new low since March 21st, with a daily drop exceeding 0.4%.

The market's expectations of possible actions by the Bank of Japan continue to rise. According to a report by Kyodo News, Japan's top foreign exchange diplomat stated on Wednesday that if the yen were to fall excessively under the leadership of speculators, Japan would not rule out the possibility of intervening in the market. He also mentioned that there are no restrictions on Japan's intervention in the market. In recent days, there has been increased speculation in the market about Japan's official purchase of yen to raise the yen-to-US dollar exchange rate. Last week, Japanese authorities were suspected of spending 3.5 trillion yen (22 billion US dollars) on intervention, showing their deep concern about the depreciation of the yen.

In the past 12 months, the yen has depreciated by about 11%, falling to its lowest level since the 1980s, making it the worst-performing currency among the G10 currencies. Despite the Bank of Japan raising the short-term policy interest rate for the first time since 2007 in March, the yen bears still dominate. This depreciation has had a profound impact on the Japanese economy, especially in terms of the inflationary effect on domestic prices. Although the depreciation of the yen is beneficial for boosting exports, many Japanese companies have production facilities overseas, and this advantage has become limited.

The Bank of Japan and the Federal Reserve will hold monetary policy meetings later this month, and Japanese authorities are working hard to maintain the stability of the yen exchange rate before that. Most economists surveyed by Bloomberg expect that the Bank of Japan will not raise interest rates at the end of the two-day meeting in late July, and not raising interest rates may lead to another decline in the yen. Lee Hardman, a senior currency analyst at MUFG Bank Ltd., believes that the yen's fluctuation “is mainly driven by the liquidation of short positions,” and he added that comments from Japan's digital minister about the need for the central bank to raise interest rates, as well as remarks on the yen exchange rate by former US President Trump, may be the driving forces behind the scenes.

Roberto Cobo Garcia, head of G10 foreign exchange strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid, pointed out: “We have seen some capital flows indicating that institutional investors may take profits before the meetings of the Bank of Japan and the Federal Reserve. Hot money has been shorting the yen for months, and it now looks like a short squeeze.”

According to Hideo Hayakawa, a former member of the Bank of Japan, the Bank of Japan is unlikely to raise interest rates this month. Instead, the reduction in bond purchases will be slightly higher than expected to avoid exacerbating the yen's weakness. “I don't think there will be an interest rate hike in July,” Hayakawa said in an interview on Wednesday. “Looking at the recent data, it is difficult to confirm that the economy's development definitely meets the Bank of Japan's expectations.”

Hayakawa pointed out that due to the long-term decline in real wages, Japan's consumer spending has been declining every quarter in the year ending in March, which is an unexpected sign of weakness for the Bank of Japan. He said that the central bank needs more time to assess the data released this summer, and the economy is expected to pick up. Hayakawa's remarks support the views of most observers of the Bank of Japan, who believe that the Bank of Japan will not raise interest rates at the end of the two-day meeting on July 31st. Economists who still believe that there will be an interest rate hike this month consider the weakness of the yen to be a key factor.

Japan's Digital Minister Taro Kono called on the Bank of Japan to raise interest rates in an interview on Wednesday to boost the yen exchange rate and reduce energy and food prices. He also hinted at his intention to run for prime minister. Kono emphasized the problems brought about by the significant depreciation of the yen against the US dollar, including the inflationary effect on domestic prices. He said, “Currency is a problem for Japan. The yen is too cheap, and we need to let it rise.” Kono's remarks may put pressure on the Bank of Japan's policy committee to raise interest rates at the end of the month's meeting.

Kono has long stated that his ultimate goal is to become prime minister. He avoided answering whether he would replace Fumio Kishida in the ruling Liberal Democratic Party's presidential election in September. Given the dominant position of the Liberal Democratic Party in the parliament, its leader is almost certain to become prime minister. Japanese media recently reported that Kono has revealed his intention to run for election to Deputy Prime Minister Taro Aso, but Kono refused to confirm these reports.

Although most economists surveyed expect that the Bank of Japan will not raise interest rates at the end of the two-day meeting on July 31st, not changing interest rates may lead to another decline in the yen. The central bank's more aggressive reduction in bond purchases may help the yen, but for some market participants, it may also seem too radical. Economists pointed out that this meeting is almost impossible to satisfy everyone.

Tsuyoshi Ueno, a senior economist at NLI Research Institute, said, “For the Bank of Japan, this is a difficult decision. My basic judgment is that there will be no interest rate hike at this meeting, but this possibility cannot be ruled out.” Charu Chanana, a strategist at Saxo Capital Markets in Singapore, is one of the market analysts who pointed out that the Bank of Japan tends to disappoint the market and keep the yen under pressure. She noted that the impact of Japan's intervention measures is weakening.

Chanana said, “Without a coordinated effort and a fundamental shift, intervention measures are unlikely to sustain the strength of the yen.” However, some economists believe that the diminishing effect of intervention measures may prompt the Bank of Japan to take action. Hideo Kumano, an economist at Dai-Ichi Life Research Institute, said, “I believe the Bank of Japan will raise interest rates again this month. Given the limited effect of intervention measures, if the Bank of Japan can take action to help the yen now, it will be praised by the government.”

As the Bank of Japan's monetary policy meeting on July 31st approaches, market attention to the yen exchange rate will further increase. The Bank of Japan's decision, whether to raise interest rates or maintain the status quo, will have a profound impact on the global foreign exchange market. Against the backdrop of increasing global economic uncertainty, fluctuations in the yen exchange rate may become more intense. Therefore, market participants need to closely monitor the policy trends of the Bank of Japan and also pay attention to the development trends of the global economy in order to better cope with the fluctuations in the yen exchange rate.