As the US Federal Reserve and other major central banks embark on vigorous interest rate rises to combat inflation, Japan is now the only country in the world that still has negative rates.
It paid the price for that position on Thursday, after the Swiss National Bank lifted its rates into positive territory. A pledge by the Bank of Japan to stick with its ultra-loose monetary policy drove the yen to a 24-year low. Within hours, Tokyo intervened to buy its own currency for the first time since the late 1990s.
This action is unlikely to have any useful economic effect, but nor is it likely to do too much harm; and given the political struggles of Fumio Kishida’s government it is understandable. Japan’s G7 partners should not protest too loudly.
The yen has lost about one-fifth of its value against the dollar this year, the slide accelerating as the Fed’s rapid monetary tightening has opened a significant interest rate differential.
The Kishida government, whose popularity is flagging, is under pressure to help those who lose out from a weakening currency — including importers, and pensioners who are on fixed incomes and face sharp increases in food prices. Consumer price inflation reached 3 per cent in August, its highest since 2014. Had the government not stepped in when the yen neared ¥146 to the dollar, the level that prompted intervention during the Asian financial crisis in 1998, it would have faced questions from an angry populace.
The currency has also been trading for months without clear levels of either technical or psychological resistance. Hedge funds and asset managers — mostly based in Europe and the US, rather than Japan — have built up sizeable short positions against the yen. The point of last week’s intervention was to warn those investors that their trades are not a one-way bet; there is a line around the level of ¥145 they should keep in mind. The government hopes thereby at least to slow down any further depreciation. Doing so is not too costly: at these levels, the Japanese authorities are getting a good deal when they sell dollars from the country’s near-$1.2tn foreign exchange reserves in order to buy yen.
They should, however, be cautious of setting more ambitious goals. Past experience suggests unilateral foreign exchange interventions almost never lead to a meaningful or sustained impact on a currency. The government should be wary of trying to defend any particular level of the currency or getting into a battle with markets that they cannot win. Sending a message is one thing. Actually strengthening the yen is quite another. Any further intervention should be sporadic and unpredictable.
Intervention will not have big effects because there is a fundamental reason for the yen’s fall: the yield differential between the yen and the dollar. The much deeper question, therefore, is whether the BoJ should raise interest rates in order to strengthen the yen. The central bank, however, sets interest rates in order to manage economic activity and inflation. If it suddenly switched its policy target to the exchange rate this would compromise its efforts on both. Japan’s low interest rates reflect its 30-year struggle to generate meaningful domestic inflation and sustain full economic activity.
As Haruhiko Kuroda, the BoJ governor, observed this week, with clear differences in its “economic and price situation”, Japan does not need to remove negative rates just because other countries have done so. The challenge is whether that is politically sustainable or whether Kishida will feel obliged to replace Kuroda with a more hawkish governor when his term expires next year. If a bit of yen intervention buys the political space for coherent monetary policy then the benefits are probably worth the costs.