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Japan’s approach to managing the yen’s volatility could be on the cusp of a significant shift, potentially moving from supporting the currency to selling it. The yen’s recent plunge to levels not seen in nearly 40 years, a factor contributing to the resignation of a Japanese prime minister earlier this week, has prompted the Bank of Japan (BOJ) to intervene repeatedly by buying yen.
However, the BOJ’s decision to raise interest rates on July 31, coupled with warnings of further hikes, has disrupted the “carry-trade” dynamic that previously weakened the yen. This policy shift briefly triggered substantial stock market volatility both in Tokyo and globally, suggesting that the yen’s recent movements might have overshot expectations.
Historical patterns suggest that after periods of yen-buying interventions, the BOJ has occasionally turned to yen-selling interventions to counteract excessive appreciation. Nomura, Japan’s largest brokerage, recently highlighted this possibility, noting that while it isn’t yet their primary scenario, future Ministry of Finance (MOF) interventions to curb yen strength could be on the table.
The yen’s fluctuations reflect its historical tendency to overshoot during periods of economic stress and speculative trading. The most notable interventions in recent decades include the Plaza Accord of 1985, aimed at weakening the dollar, and the Louvre Accord of 1987, which sought to stabilize it. Japan has also alternated between buying and selling yen at extremes over the years to manage currency volatility.
In the aftermath of the 2007-2008 financial crisis, global interest rates converged around Japan’s zero level, dampening carry-trade activities and stabilizing the yen. However, recent interest rate hikes in other G7 economies, along with the post-pandemic economic shifts, have reignited carry trades and contributed to yen volatility.
Looking forward, the potential for a stronger yen remains, especially if G7 interest rates decline and Japan’s economic conditions improve. If Japan’s economic recovery continues and inflation pressures ease, the government might be tempted to further normalize rates. While a stronger yen could benefit from reduced import costs and enhance domestic consumption, excessive appreciation could harm exporters and the broader economy.