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Opinions Joost Derks

Horror moment for the yen is getting closer

31 January 2024 - Joost Derks

It is only a matter of time before the significant interest rate gap between Japan and the rest of the world narrows. For the time being, however, the currency world will have to be patient. In anticipation of a major catch-up, the yen will first take a step back.

It's rare that a horror movie stands out because of its strong storyline. Instead, it is mainly the big scare moments that linger. You sense in advance that things are not going well when a group of friends take shelter in an old, dilapidated house on a rainy night. But you're still shocked when the monster strikes when you least expect it. In 2024, the yen could surprise in the same way on currency markets. It is already clear that the currency will benefit from a shrinking interest rate difference between Japan and the rest of the world. The big question is when exactly that will happen.

Brace yourself for a moment of shock
At the end of last year, some parties had already braced themselves for a serious yen scare. The Japanese central bank seemed to be preparing to raise interest rates a notch. Since 2016, the Bank of Japan's (BoJ) key rate has stood just below 0%. On the other hand, falling inflation in the United States and Europe seemed to pave the way for the Federal Reserve and European Central Bank (ECB) to cut the policy rate in the spring. In recent years, an increasing interest rate differential has made it increasingly attractive to transfer assets from Japan to countries with more attractive interest rates.

BoJ tests patience
Mainly due to this capital outflow, the yen fell by 2020% against the euro between the end of 23 and mid-November of this year. Compared to the dollar, the currency even fell by more than 30%. But that decline suddenly came to an end at the end of last year. For a while it looked as if the BoJ would use the December 19 policy meeting to prepare for an interest rate increase. The inflation rate of more than 3% was clearly above the official target of 2%. However, as in recent years, the BoJ stuck to its stick-to-it approach. The expectation for the first Japanese interest rate increase has now been pushed back from April to sometime at the end of the first half of the year.

Postponement, but not adjustment
In the United States and Europe, inflation is somewhat higher than what central banks are aiming for. Because the economy is still doing well and the labor market is tight, an interest rate cut in these regions is still pending. For the time being, the interest rate gap between Japan and the Western world is not shrinking at all. And that is felt on currency markets. The gains that the yen made in the run-up to New Year's Eve evaporated like snow in the sun in January.

Export companies and traders should not be misled, however, because BoJ Chairman Kazuo Ueda is determined to normalize Japan's extreme interest rate policy this year. So it's only a matter of time before a yen catch-up scares the currency world.

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.

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