The yen faces an uncertain future

While central banks around the world are lowering interest rates, the Bank of Japan will increase its main rate later this year. It is a matter of time before currency traders start anticipating a policy change in the Asian country.

There is little sign of a quiet holiday period on currency markets. At the end of last week, the Japanese yen in particular attracted attention. The currency rose by more than 2% against Western currencies such as the dollar and the euro. For once, that revival was not caused by an interest rate decision or a geopolitical event such as an unexpected election result. Instead, the yen received a powerful boost as the central bank intervened in currency markets. Data published by the Bank of Japan (BoJ) on Friday shows that more than 3,5 trillion yen - about €20 billion - in aid purchases have been made. However, previous interventions were insufficient to stop the yen's free fall.

Drop on a hot plate
The Japanese currency has fallen 2021% against the dollar since the start of 35. Compared to the euro, the exchange rate damage amounts to 27%. The difference is explained by the fact that inflation rose sharply in the Western world three years ago. In response, central banks in the United States and Europe have sharply raised policy rates to 4% or even higher. Meanwhile, Japanese interest rates have crept up from -0,1% to 0,1%. It is therefore very attractive for savvy financial parties to borrow money in Japan and invest it in another region at a higher return. As long as these so-called carry trade continues, the BOJ's bailout purchases are a drop in the ocean.

July 30: important day for the yen
However, this seems to be slowly but surely changing. The BoJ board will meet on July 30 for a meeting to discuss the policy to be pursued. The chance that the policy interest rate will rise again after the increase in March is quite small. But an important signal is also sent if an interest rate increase is planned for later in 2024 in combination with the phasing out of the support package. Currently, the BoJ is buying 5 to 7 trillion yen worth of government bonds and other assets every month in an attempt to stoke inflation. That goal now appears to have been achieved. In May, inflation rose from 2,2% to 2,5%.

Will the policy change happen?
If the central bank expressly anticipates a policy change, this is a sign for traders that they should start reducing their carry trade. This movement could gain momentum if Western central banks reduce policy interest rates somewhat in the course of 2024. This also contributes to narrowing the interest rate gap between Japan and the rest of the developed world. Slowly but surely, the tide seems to be turning for the yen after the enormous depreciation in recent years. Before that happens, the BoJ must first convince the currency world that the policy change will actually happen. Until then, the bank is clearly swimming against the tide with any form of support for the yen.

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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