The yen has fallen past 163 against the dollar for the first time since December 1986, reaching its lowest value in 40 years. The decline is attributed to increased demand for the dollar as a safe asset amid escalating tensions in the Middle East, coupled with rising international oil prices that heighten the likelihood of U.S. interest rate hikes. Analysts suggest that Japan's proactive fiscal measures and the Bank of Japan's (BOJ) slow rate increases, along with a perception that monetary authorities may not act decisively, have further exacerbated the yen's weakness.
On July 21, the yen's exchange rate briefly reached 163.24 per dollar, marking the highest level in nearly 39 years and 7 months. After fluctuating between the low 161 yen and mid-162 yen range for the past two weeks, the yen surged past the previous high of 162.84 yen recorded on July 1, driven by a wave of stop-loss selling. The yen's decline continued in the Tokyo market on July 22, where it reached 163.21 yen per dollar at one point.
The immediate catalyst for this decline was the worsening situation in the Middle East. The Asahi Shimbun reported that fears of escalating conflict between the U.S. and Iran have accelerated dollar buying. The Yomiuri Shimbun noted that the Iran-aligned Houthi rebels in Yemen declared a maritime blockade against Saudi Arabian vessels, contributing to rising oil prices and yen selling.
West Texas Intermediate (WTI) crude oil prices rose to around $85 per barrel. Concerns about renewed inflationary pressures in the U.S. due to rising oil prices have strengthened expectations for interest rate hikes by the Federal Reserve, with the yield on U.S. 10-year Treasury bonds climbing to approximately 4.6%. The probability of a Fed rate hike in July, as reflected in the U.S. short-term interest rate futures market, increased from 16% to 26.2%. Rinto Maruyama, a senior interest rate and currency strategist at SMBC Nikko Securities, analyzed that the expectations for U.S. rate hikes and the widening interest rate gap between the U.S. and Japan have led to continued yen selling and dollar buying.
The rise in oil prices has also increased Japan's energy import costs, further contributing to the yen's decline. Atsuhide Sakamoto, a senior economist at Mitsubishi UFJ Morgan Stanley Securities in New York, explained that the increase in energy import costs could widen the trade deficit, raising long-term pressures on the yen.
However, the current yen depreciation cannot be solely explained by the dollar's strength amid Middle East instability. The dollar index, which measures the dollar's value against major currencies, rose by 0.2 points to around 101, yet the yen hit its lowest level in 39 years and 7 months. The yen-euro exchange rate also climbed to the low 186 yen range per euro, marking the lowest value for the yen in about a month. During the past two weeks of renewed U.S.-Iran conflict, the yen has depreciated by 0.6% against the dollar, making it the weakest among the ten major currencies (G10) with high trading volumes. In contrast, currencies like the New Zealand dollar, which continue to raise interest rates, have seen buying interest even in a strong dollar environment. While Middle East tensions may have triggered the yen's decline, internal factors in Japan have amplified the drop.
In fact, the yen-dollar exchange rate was around 147 yen per dollar when Sanae Takaichi's administration took office in October last year, but concerns over proactive fiscal measures have led to a rise of more than 16 yen in just nine months. The Nihon Keizai Shimbun (Nikkei) reported that after the Japanese government confirmed its 'Basic Policy on Economic and Fiscal Management and Reform' (Honebuto Policy) at a Cabinet meeting on July 21, the perception that the government is effectively accepting yen weakness has spread in the market.
This policy changed the wording from 'fiscal consolidation' to 'fiscal sustainability,' which was included in previous years. Although the government added a clause respecting the independence of the BOJ that was not in the original draft, the market did not view it as a factor that would reverse the yen's decline. Kosuke Hanao, head of Valta Research, pointed out, "The government's economic policy is ultimately leading to a direction that accepts yen weakness, and the market believes that monetary authorities will not be able to act decisively."
Concerns that the BOJ may delay interest rate hikes and fiscal instability due to tax cuts have also been identified as factors contributing to the yen's weakness. Maruyama noted that fears of the BOJ lagging behind in responding to inflationary pressures from rising oil prices are fueling the yen's decline. He indicated that considering the declining approval ratings of the Takaichi Cabinet, there is a high likelihood that a tax cut proposal to lower the consumption tax rate on food to 1% will be pursued, but discussions on securing funding have been postponed under the Honebuto Policy, raising concerns about fiscal deterioration.
As the yen falls to its lowest level in 39 years and 7 months, concerns about market intervention have increased. Finance Minister Satsuki Katayama stated on July 22, "We will respond appropriately and decisively whenever necessary," hinting at the possibility of market intervention. However, she refrained from commenting on specific exchange rate levels, stating, "The government's policy has not changed." Despite Katayama's remarks, the foreign exchange market showed little reaction. The Nikkei reported that a cynical view is spreading in the market that mere intervention will not address the fundamental causes of the yen's weakness.
In reality, the Japanese government lacks a strong justification for immediate market intervention. While the exchange rate has risen, the pace of the yen's decline has been relatively moderate. The expected volatility of the yen over the next month is in the low 6% range, lower than the 8% range seen on July 1 when the exchange rate surged. The Nikkei pointed out that with the current movements, it is difficult for the Japanese government to argue that there is 'excessive volatility,' which has been its justification for foreign exchange market intervention.
Akihiro Kawakami, an analyst at Mitsubishi UFJ Bank, predicted on July 22 that the yen could fall to around 163.50 per dollar in the Tokyo market. The market is now discussing 165 yen as the next critical threshold. The Nikkei warned that if the Japanese government continues its passive stance, corporate dollar buying and the 'yen carry trade'—borrowing yen at low interest rates to invest in high-yield assets—could further drive the yen's value down to around 165 yen per dollar. Mari Iwashita, chief interest rate strategist at Nomura Securities, suggested that if the yen's value drops to 165 yen before the BOJ's monetary policy meeting in September, the government may intervene to buy time.
* This article has been translated by AI.
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