5.9 JP Yen
5.9 JP Yen
5.9 JP Yen
The gulf exists because of differences in the outlook for inflation. It is still
unclear just how emphatically Japan has broken out of the low-inflation—
and at times deflationary—trap in which it has been stuck since asset prices
collapsed in the 1990s. Although headline annual inflation has been above
the central bank’s 2% target for nearly two years, there are signs that price
rises have been slowing. Rightly, rate-setters at the Bank of Japan seem
more concerned with hitting their inflation target than with using monetary
policy to support the yen. All told, therefore, the country’s interest-rate
outlook is diverging from America’s, where there are growing worries that
inflation is not falling as it should and that the Federal Reserve will, as a
result, not cut interest rates any time soon.
Given that Japan has an open capital account, an inevitable side-effect of its
low relative interest rates is a weak currency. Higher rates abroad make
profitable a “carry trade”, whereby investors borrow in yen and invest in
dollars; that weakens the yen and strengthens the greenback. In theory, the
yen must depreciate until its cheapness—and hence the higher likelihood of
a rebound in future—means this trade is no longer expected to yield profits.
Currencies can overshoot the fundamentals, but it is difficult to tell when
they have, and harder still to calibrate an appropriate response. The
thresholds at which the Japanese government has chosen to intervene are
arbitrary. It says that volatility in the currency has been excessive, but its
opaque criteria for selling reserves may well have made that problem
worse.