As the yen approaches its weakest level since 1986, the long-held belief that the currency will eventually rebound is being shaken to its core. In particular, the aggressive fiscal policy that the Takaichi government is pursuing to revive the economy is increasing the supply of Japanese government bonds and pushing up interest rates, yet it is failing to translate into a stronger yen. Analysts say this is because Japan's economic fundamentals are weakening, leaving demand to support the yen insufficient over the medium to long term.
The Japan Times recently reported, citing multiple analysts, that the likelihood of a future appreciation of the yen is low and that it could surge to as much as 200 per dollar. As of 6:30 p.m. on Sunday, Korea time, the yen traded at 161.87 per dollar, exceeding the previous session's closing price of 161.74 yen. This is close to the dollar-yen exchange rate record of 162.70 yen set on Dec. 23, 1986, during Japan's bubble economy era.
Daiju Aoki, head of the UBS Japan office and regional chief investment officer (CIO), said, "The risk that yen weakness continues over the medium to long term is not small," adding, "We are warning clients of the possibility of 180 yen, or even 200 yen, per dollar."
According to the Japan Times, this outlook stems from Japan's declining economic growth rate and the emergence of structural deficits in its trade environment. According to the International Monetary Fund (IMF), Japan's real gross domestic product (GDP) growth rate last year was 1.19%, ranking 160th in the world, while the United States posted 2.12%, ranking 135th.
The Bank of Japan implemented large-scale quantitative easing after 2013 with the goal of escaping long-term deflation, but as the trade deficit became entrenched and the current account surplus failed to return home due to increased overseas reinvestment, demand for the yen declined. The Japan Times also assessed that Japan's recent stock market strength has been driven by a small number of foreign investors.
Maki Ogawa, senior analyst at Sonae Financial Group, said, "Japan has shifted from a goods-exporting country to one that earns money through overseas investment," adding, "In a situation where capital continues to flow abroad, it is difficult to expect yen strength."
Against this backdrop, after Russia's invasion of Ukraine in 2022, the United States aggressively raised interest rates to curb inflation, widening the interest rate gap between the United States and Japan significantly. Aoki, the CIO, said, "US interest rates are high while Japanese rates have not risen sufficiently, so pressure for a strong dollar and a weak yen continues," but added, "Since last year, yen weakness that is difficult to explain by the interest rate gap alone has persisted."
The biggest factor is Japan's announcement of large-scale fiscal spending since the launch of the Sanae Takaichi cabinet last October. Through a draft of its "Basic Policy on Economic and Fiscal Management and Reform" (Honebuto policy) on Sunday, the Takaichi government has put forward aggressive fiscal policy head-on, setting a goal of more than 370 trillion yen (3,532 trillion won) in public-private investment in strategic fields such as AI and semiconductors by 2040.
Analyst Ogawa said, "Since the launch of the Takaichi government, its aggressive fiscal policy has begun to draw the attention of foreign investors," adding, "Whereas previously the yen was weak because of low interest rates, now we are seeing a 'bad rate increase' in which the yen weakens even as long-term rates rise."
In other words, normally, when the Japanese government issues more government bonds to raise funds, bond prices fall and long-term interest rates rise. However, as the market sees it, this rise in rates is not because the economy is growing but because of fiscal deterioration and instability in bond supply and demand. In such cases, confidence in national finances is instead shaken, and foreign investors come to prefer yen assets less, which can weaken the yen.
Market experts predicted that intervention by the Japanese government in the foreign exchange market would also have little effect. The prevailing view is that expectations of further US rate hikes are growing, while the Bank of Japan's rate hikes have already been priced into the market. There are even voices saying that the Japanese government is tacitly tolerating the situation, given that some Japanese companies are expected to benefit from the weak yen.
However, Analyst Ogawa countered, "A weak yen increases the burden of living costs and hurts households, so if the government is mindful of approval ratings, it cannot help but be concerned," adding, "Prime Minister Takaichi needs to more actively mention the negative impact of the weak yen on households. The perception that the government condones the weak yen encourages further yen weakness."
