A Look Behind The Fall of the Japanese Yen

Japan’s lackluster economic fundamentals, aggressive monetary easing, improving global growth prospects and investor sentiment are driving a correction in the Japanese yen‘s (JPY) value; the currency has lost 17% against the US dollar since September 2012.

The Japanese economic picture is bleak, although the country’s policymakers are adopting aggressive pro-growth policies. Real GDP contracted by 0.1% in the final quarter of 2012 following a 1.0% drop in the July-September period, limiting the economic expansion to 1.9% for 2012 overall. With the tsunami-related reconstruction boom coming to an end, investment remains subdued, adversely impacted by deflationary pressures that make borrowing unappealing and encourage companies and consumers to postpone spending. One of the biggest problems weighing on the economy is the closure of the nuclear power plants that the country was do dependent on.  It is expected that Prime Minister Abe, will allow the reopening of some of the power stations once they have passed safety requirements, thus lowering the demand for energy imports.

China is the most important export destination for Japan (purchasing 20% of Japanese exports), its revival will be significant for the Japanese external sector; nevertheless, strains between China and Japan over the Senkaku Islands will continue to dampen demand for Japanese products in the near future but the most recent trade balance release, although fairly poor showed an increase of exports to China. With China’s rebound and tensions easing this should help the Japanese economic situation.

The newly elected Japanese government will continue their decisive fight against deflation, relying on quantitative easing measures to influence the cost of long-term funding. In January, the Bank of Japan (BoJ) introduced an “open-ended asset purchasing method”, effective January 2014, committing to buying a certain amount of financial assets (around ¥13 trillion) every month without establishing a termination date for its pledge. The total size of the Asset Purchase Program for 2013 remained unchanged at around ¥101 trillion, while it will be raised by around ¥10 trillion in 2014. The central bank also increased its inflation target from 1% to 2%, as forcefully advocated by Prime Minister Shinzo Abe. This has caused rumors of a currency war as global exporters cannot compete against Japanese exporter with the weak JPY. This is a two edged sword as it also increases the cost of the much needed energy products that Japan imports. And will cause inflation.

The BoJ governor Masaaki Shirakawa announced his decision to step down on March 19th, a few weeks ahead of schedule. Now, key central bank posts will likely be filled with policymakers who take full responsibility of meeting the new inflation target, and who assent to Mr. Abe’s economic views more broadly. Prime Minister Abe is expected to announce his nomination in the next few days.

The JPY has been trading in a range between 92-95 over the past weeks since the stimulus program but seems to have locked into a tight range hugging the 93.50 price level. As the euro tumbles against a stronger US dollar the EUR/JPY is falling to trade at 123.83 off its recent highs just under the 130.00 price level.