Analysis: Yen May Weaken Further as Interest Rates Diverge

The yen may weaken more in coming months on expectations that the interest-rate gap between Japan and most other countries could widen further and hurt the Japanese currency, analysts said.

Bank of Japan Gov. Kazuo Ueda said Wednesday that the central bank isn’t yet confident enough to alter its super-accommodative monetary policy and argued that Japan’s underlying inflation is still below the central bank’s target of 2%. On the same day, Federal Reserve Chair Jerome Powell said that the U.S. central bank is likely to keep raising rates despite leaving rates unchanged earlier this month.

“The combination of sticky U.S. inflation, which keeps the Fed from reversing rate hikes, and a patient BOJ, which limits the extent of policy normalization, could prolong the yen weakness,” said Shusuke Yamada, FX/rates strategist at BofA Securities Japan, in a recent research report. BofA Securities Japan also raised its third- and fourth-quarter dollar-yen forecasts to 147 from 143 and to 145 from 140, respectively.

The U.S. dollar was recently at 144.15 yen after touching JPY144.63 on Wednesday, its highest intraday level since November 2022. The yen is on course to weaken about 8.1% against the dollar this quarter, the largest quarterly depreciation since April-June 2022, according to FactSet.

The BOJ at its June 16 policy decision left short-term interest rates at minus 0.1% and maintained the cap on the 10-year Japanese government bond yield at 0.5%. On the other side of the Pacific, Fed officials this month kept the benchmark federal-funds rate in a 5%-5.25% range after raising it rapidly over 10 straight meetings. Another increase at the Fed’s July 25-26 meeting would bring the policy rate to a 22-year high.

The difference in policy rates weakens the yen as investors typically sell a currency that gets low interest rates and use the proceeds for investments in assets denominated in currencies that have high interest rates.

“The key fundamental driver of yen weakness is the policy divergence between the Fed and the BOJ, which appears in no hurry to shift away from its yield-curve-control policy yet,” says Alvin T. Tan, head of Asia FX strategy at RBC Capital Markets.

To be sure, some analysts think the yen could strengthen given the risk of foreign-exchange intervention by the Japanese authorities or possible adjustments to the Bank of Japan’s yield-curve-control policy.

Just Tuesday, Japan’s Finance Minister Shunichi Suzuki highlighted his view that yen-dollar exchange rate movements are “one-sided and rapid.”

Asked whether Japan was considering yen-buying intervention in the foreign-exchange markets, a strategy it used last fall, Suzuki replied that the government would “take the appropriate response” in the case of excessive movements.

The speed and extent of the yen’s weakness are limited by the risk of foreign-exchange intervention, which last happened when dollar-yen was in the 145-152 range, said Barclays foreign-exchange strategists Shinichiro Kadota and Lhamsuren Sharavdemberel in a recent research report.

Barclays also expects a one-off 3% to 5% appreciation of the yen that could result from a possible change or an abandonment of the BOJ’s YCC policy. But the impact on the yen might be contained, partly owing to possible dip-buying demand in dollar-yen, the strategists added. The U.K. bank forecasts dollar-yen at 137 in the third quarter and 135 in the fourth quarter.