Deadly sin: this is how Japan throws away tens of billions

For the first time in more than two decades, Japan is intervening in currency markets to prevent the yen from falling too hard. However, the tens of billions of euros in aid purchases are wasted as long as the central bank keeps interest rates low.

If you spend €40 billion on something, it is nice to see something in return. That amount is about the same as the economy of Estonia as a whole. Still, there's little sign of Japan spending such an amount in October on measures to stop the yen's fall. Despite support purchases of approximately €40 billion, the currency is still very close to its lowest point in more than ten years compared to the European currency. In about 2,5 years, the yen has lost more than 20% of its value.

Interest rate gap widens
The main reason for this sharp fall in prices is the interest rate hikes of the European Central Bank. On the other side of the world, the Bank of Japan (BoJ) is stubbornly sticking to a key rate of just under 0%. Until that changes, the interest rate gap will only widen. This does not only apply to the difference with interest rates in Europe, by the way. In the United States, the key interest rate has risen from just over 0 to 3% within a year, while the Bank of England also raised interest rates by three quarters of a percent to 3% this week. Rising interest rates are making it increasingly attractive for parties to exchange their yen for other currencies.

Why is Japanese inflation so low?
It doesn't look like the Bank of Japan will raise interest rates any time soon, so that the big difference with other countries will become smaller. Inflation is much lower than in Europe or the United States. In the current year, Japan is heading for an inflation rate of 2% and by 2023 it will be less than 1,5%. An important reason for the low inflation is that energy weighs less heavily in the purchasing power basket than in other countries. Another factor is that the Japanese housing market has become much less overheated than in the United States and Europe. Low wage growth is another reason why inflation is so low. Salaries will hardly increase as a result of an aging population and the lack of dynamism in the economy.

Mopping with the tap open
Low inflation seems very attractive in these times, but this puts the country in a financial dilemma. BoJ chairman Kuroda Haruhiko has already hinted that he will leave interest rates unchanged until the end of his term in 2023. This indicates that the interest rate differential with the rest of the world is only widening. But this has already pushed the yen to its lowest level against the dollar in more than XNUMX years. A very cheap yen discourages investment in the Japanese economy, which is much needed to stimulate growth. Viewed in this way, it is not at all surprising that the country spends tens of billions on support purchases of its own yen. But as long as the Japanese interest rate remains negative, that is wiping with the (money) tap open.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.