Falling Yen, Falling Fortunes for the BOJ’s Ueda?

Engineering a Skilled About-Face

In April 2023 Ueda Kazuo took the helm as governor of the Bank of Japan. While he originally hailed from academia, he served a lengthy stint on the bank’s Policy Board and was well-versed in the hands-on aspects of monetary policy. His predecessor at the top, Kuroda Haruhiko, had implemented a long-running program of monetary easing “of a different dimension,” but this combination of quantitative easing and negative interest rates had been joined by measures to guide Japan’s long-term interest rates, making it a most complicated program for Ueda to take over. Still, according to one retired BOJ official, he was seen as the perfect man for the job of dismantling the “Kuroda bazooka.”

Upon taking his position as governor, Ueda first signaled a dovish approach to policy change, indicating that he would be cautious in returning the central bank’s policy to normal. Under Kuroda the BOJ had purchased massive amounts of Japanese government bonds, and a hasty move to raise the rates under the bank’s control would cause their value to plummet, driving up interest rates across the board.

Emblematic of this caution was a speech Ueda gave before the Naigai Jōsei Chōsakai research organization in May 2023, in which he noted that “the cost of impeding the nascent developments toward achieving the 2 percent price stability target, which are finally in sight, by making hasty policy changes would likely be extremely high.” As one major think tank analyst sees it, this meant that Ueda would rather accept the onset of inflation than more too quickly to unravel Kuroda’s policy and end in failure; rather than speedily normalizing Japan’s monetary policy, the new governor probably felt it would be enough to put an end to negative interest rates while he was in office.

Once he arrived in that office, though, he moved swiftly to incrementally raise the bank’s long-term rate guidance, laying the groundwork for a full normalization of Japan’s monetary stance. From January 2024 onward, he also began sending stronger messages on the BOJ’s eventual cancellation of its negative interest rates and related policies. In February, Deputy Governor Uchida Shin’ichi gave a speech at a Nara Prefecture gathering of financial and business actors in which he outlined the bank’s likely blueprint for correcting its massive monetary easing course. With the preparations in place, in March the central bank was ready to end its negative interest policy.

I spoke to one overseas fund manager who told me that Ueda had displayed “magnificent skill” in ramping down the BOJ’s massive easing program, without undue chaos, in less than a year since taking office. Indeed, it almost seems like the dovish face Ueda put on soon after taking office was merely a façade aimed at calming the market. In point of fact, the BOJ’s raising of its guidance on long-term interest rates does indeed amount to an effective rate hike, but Ueda’s positioning of this step as a mere technical adjustment allowed him to prepare the market as a whole for eventual shifts away from the bank’s longstanding program of massive easing. It may be too early to declare this a success in the final tally, but as of March 2024, at least, Ueda has produced a winning record.

The Political World Steps In

We must recognize that the bank’s actions on the policy stage since then have not been so confident. The yen has plunged against the US dollar on exchange markets, and the BOJ itself has appeared to play the role of an actor whose flawed choices have accelerated the decline of the Japanese currency. One might specifically point to Governor Ueda’s April 26 press conference, following the bank’s Monetary Policy Meeting the same day. The bank’s decisions were basically just as expected, maintaining its status quo in short-term call rates and JGB purchases. As one major Japanese bank official put it, though, this meant that “the BOJ did little more than present cautious statements on rate hikes, effectively giving the green light to a fall in the yen’s value.”

In particular, Ueda’s statement that the downward trend in the yen’s value was not yet triggering any ongoing rise in consumer prices served to further boost yen-selling on currency markets, bringing the yen down to an intraday level of more than 160 to the dollar on April 29 before rising back into the 150s. The Japanese government had no choice but to embark on a major market intervention to prop the yen up; according to Ministry of Finance figures for April 26 to May 29, total intervention was north of ¥9.79 trillion.

It bears noting that currency markets are the proper remit of the Finance Ministry; the Bank of Japan should not be concerning itself with foreign exchange as part of its focus on price stability, and meddling in currency markets is supposed to be off-limits for it. It has become clear, though, that this division of tasks is little more than a formality, and the BOJ will be pulled into the ring when severe foreign-exchange turmoil is seen.

It also bears noting that the government was in fact concerned about Ueda’s moves potentially accelerating a fall in the yen’s value, given the chance that this could deal a blow to household budgets. On May 7, Prime Minister Kishida Fumio called Governor Ueda in for a meeting. Immediately after this, Ueda told assembled journalists that he and the prime minister had confirmed the need to keep careful watch on the yen’s value in determining BOJ policy going forward.

According to the overseas fund manager mentioned above, it was certain that Ueda had received his marching orders in the meeting with Kishida, and the BOJ was now required to be concerned above all else with foreign exchange rates in determining its next policy steps. Indeed, in the government’s revised version of its Grand Design and Action Plan for a New Form of Capitalism, announced on June 7, it stated that the government and the Bank of Japan would work closely together to achieve sustainable, stable 2% annual rises in consumer prices. Given the impact of the falling yen on prices since the beginning of the year, the plan said, it would be necessary to pay close attention to the yen’s value on foreign currency markets.

Remaining Cautious About Big Blows to the Economy

One particularly troublesome factor the BOJ must deal with is the fact that its monetary policy decisions cannot be deployed as they once were to deal with the excessively high value of the yen. In the past, there was no more room for further monetary loosening, meaning that any signals of further efforts in that direction were interpreted as little more than play-acting; this meant that while admittedly having little effect to stem the climb of the yen, they at least had no impact on the real economy.

Now, though, matters are different. Monetary measures taken in response to a softening yen are likely to trigger tightening across the economic board, dealing real blows to the economy. As another former BOJ official told me, any interest rate hikes in response to the falling yen would have a serious impact on the real economy, heightening the risk of a return to a deflationary spiral.

To make matters even more difficult for Ueda, the domestic bank official I talked to said, even a move to raise rates might have almost no effect in terms of staunching the fall of the yen. Japan has adopted a floating exchange system that allows rates to shift freely, and the present decline in the value of its currency (against the US dollar in particular) is rooted largely in the spread between interest rates in the United States and Japan. So long as capital flows toward the dollar, where it can expect higher returns, the yen will see no stability in its own value vis-à-vis that currency unless Japan’s authorities move to close the rate spread. The US Federal Reserve Board’s current effective federal funds rate is north of 5%, meaning the BOJ would have to approach this level to see an impact.

In point of fact, of course, the Japanese economy could never withstand interest rates hiked to this range. Given the enormous public debts on Japan’s books, any serious rate hike could trigger a catastrophic plunge in the JGB market. In short, as observers have noted, the forex markets are well aware of the fact that the BOJ has little it can do in terms of raising rates. Only a handful of rate hikes would be possible with the aim of heading off further falls in the yen’s value, and none of them would be sufficient to meaningfully close the gap between Japan’s rates and those in the United States. The upshot is that we can expect little more than further, gradual declines in the value of the yen.

Looking all the way back to the early 1970s, when Japan switched to its floating exchange system, we see that the country has never opted for an interest rate hike as a means to heading off falls in its currency’s value. During his time on the BOJ Policy Board, Ueda is reported to have said, “I’d like just once to implement a serious rate hike as an inflation-fighting tool.” Now, almost a quarter-century on since that point in his career, we find him in a new position as bank governor, where he may be pressed to do just that as a way to prop up the yen.

At its June 13–14 Monetary Policy Meeting, the BOJ decided to reduce its purchases of JGBs “to ensure that long-term interest rates will be formed more freely in financial markets.” This signaled a willingness to accept a certain level of increase in interest rates.

That said, there is only one thing that the Japanese government and BOJ can do to prevent further falls in the yen’s value: to hope that inflation will calm down in the Unites States, and that the US Federal Reserve Board will move quickly to reduce its own rates. On June 12, the Federal Open Market Committee issued a report projecting one further rate cut during the year—down from the three cuts projected at the beginning of 2024. It seems unlikely that the interest rate spread between Japan and the United States will close anytime soon, and US price stability remains a vital factor for the Japanese economy going forward.

(Originally published in Japanese on June 14, 2024. Banner photo: Bank of Japan Governor Ueda Kazuo answers press questions following a May 7 meeting with Prime Minister Kishida Fumio at the Kantei in Tokyo. © Jiji.)