The Yen’s Depreciation Reaches a Turning Point

As of November 24th, many believe that the yen’s depreciation has peaked despite US Federal Reserve interest rate hikes being put on hold and a focus on potential interest rate cuts in 2024. A bridge bill passed just before the November 17 deadline for the US debt ceiling, extending funding for some government agencies until January 19, 2024, and others until February 2, which is contributing to decreased US interest rates. However, Japanese economic policy, including income tax cuts, is still leading to yen selling. Prime Minister Kishida’s administration, facing dropping approval ratings, may struggle to implement drastic measures to address the situation. Additionally, the Prime Minister’s explanation of the income tax cuts as a means to combat deflation has led to doubts, potentially impacting the Bank of Japan’s decision-making. Overall, the yen’s future remains uncertain due to a combination of domestic and international factors.

As of November 24th, there is a growing view that the yen’s depreciation has already passed its peak. In this photo, Bank of Japan Governor Ueda holds a press conference at the IMF and World Bank general meetings held in Marrakech, Morocco in October (2023 Reuters / Susana Vera)

[Tokyo, 24ain]- There is a growing view that the depreciation of the Yen has already passed its peak. US Federal Reserve interest rate hikes have been put on hold, and the focus has shifted to where in 2024 they will start cutting interest rates.

On the issue of the US debt ceiling, a bridge bill was passed just before the November 17 deadline, allowing some government agencies to avoid a shutdown until January 19, 2024, and others until February 2. This is a factor in lowering rates US interest. In addition, a number of other factors are coming together to correct the yen’s depreciation.

However, looking at factors on the Japanese side, there are still deep factors for yen selling, so the yen may not appreciate as quickly.

The first reason is that the economic policy of the Fumio Kishida administration which focuses on income tax cuts is backwards. It is very difficult to recover from this difficult situation.

With the cabinet’s approval rating dropping significantly, it will no longer be possible to implement drastic measures (such as defense tax increases) as was the case until the summer. After all, it created the misunderstanding that the income tax cut would restore the support ratings of the base for the party’s economic policies to be difficult to receive high praise in the future.

Prime Minister Kishida explained that the reason for implementing the income tax cut was to overcome deflation. I could not believe my ears when I heard these words. I feel there may be an option to prevent the Bank of Japan from charging negative interest rates until the income tax cut is implemented in June.

In that case, Prime Minister Kishida’s economic measures may be a factor in the yen’s depreciation. If the Bank of Japan senses political intentions subtly, it may become more cautious about overcoming deflation.

The policies of the Kishida administration have been characterized by maintaining the status quo. For example, maintaining the price of gasoline and continuing to extend subsidies for electricity and gas bills. This supplementary budget also extends the period until the end of April. This status quo will probably be extended much longer.

In fact, Japan should move towards electric vehicles (EVs) and switch to industrial energy in order to decarbonise, but the strong support for the use of fossil fuels will slow down such structural changes. I was hoping that the restarting of nuclear power plants would proceed more quickly in the electric power sector, but things are also slow.

The difficulty in improving the trade deficit is a factor in the structural depreciation of the yen. Continuing to extend gasoline subsidies will eventually cause the Yen to weaken. A weaker yen pushes energy prices up, leading the government to increase subsidy spending. Policies aimed at maintaining the status quo will lead to a vicious cycle of increasing financial dependency.

What Japan needs today is a reform-oriented mindset that will transform the current situation into a better future. The transition to EVs is accelerating in China, Europe, and even the US, which has lagged behind. Japanese automakers are also trying to move to EVs and electrification, but simply extending gasoline subsidies makes me wonder what direction they are taking in their policy.

The automobile industry is a pillar of Japan’s exports, and as the world market tries to move away from gasoline-powered vehicles, it would be ideal for the Japanese government to support this trend.

The Kishida administration should be more concerned about the fact that export expansion is not progressing sufficiently due to yen depreciation. Instead of resting our hopes on the revival of semiconductors alone, we should focus on promoting a wider range of exports.

The Kishida administration is facing a painful sense of impasse. This is because the tax break has been backed up. For now, there will be no diplomatic events that could increase approval ratings.

In the near term, one thing that can have significant consequences is a pay rise. Looking ahead to next spring, if the party can achieve much better results than this year, it is likely that it will be able to regain some of its support.

By the way, is the wage increase a factor in the weaker yen or a stronger yen?

If the virtuous circle scenario emerges, the Bank of Japan will naturally raise interest rates. There is no need to create a large supplementary budget like this. If the government no longer expands its finances more than necessary, it will no longer be dependent on the extremely low interest rates of the Bank of Japan. It is believed that a steady rise in wages will correct the weak yen.

In mid-October, when Prime Minister Kishida talked about cutting income taxes by up to 5 trillion yen, I was concerned that this would be a “reminder” of the previous Truss administration in the United Kingdom. The Yen depreciated to a level of 151 yen to the dollar at the end of October.

However, the US consumer price index (CPI) grew at a lower rate than expected, and long-term interest rates in the US fell, leading to a weaker dollar and a stronger yen. I think it’s a blessing in disguise that the mistake didn’t lead to further yen selling.

Prime Minister Kishida may not want the Bank of Japan to correct its monetary easing. It is likely that Governor Kazuo Ueda will want to proceed to the point where he confirms wage increases and raises negative interest rates. I would like to pay attention to the extent to which Governor Ueda will be able to control policy as he wishes.

If Prime Minister Kishida had dissolved the House of Representatives before the end of the year, it would have been easier to pick up the slack next year. At present, the abolition date has been pushed back significantly. Prime Minister Kishida’s term as president of the Liberal Democratic Party ends in September 2024.

Although it is unclear when the repeal will occur, Governor Ueda certainly wants to raise negative interest rates as soon as possible in 2024. With this in mind, the excuse that the June income tax cut is implemented to overcome deflation becomes an obstacle.

The real deciding factor will be how to jump over that hurdle. If you wait until June and then try to cancel the contract between July and September, you will be approaching the cancellation date there. The Bank of Japan is in a difficult position.

Editing: Kazuhiko Tamaki

(This column was posted on the Reuters Foreign Exchange Forum. It is written based on the author’s personal opinion)

*Hideo Kumano is the chief economist of the Dai-ichi Life Economic Research Institute. He joined the Bank of Japan in 1990. After working in the Research and Statistics Office and the Information Services Office, he retired in July 2000. He joined the Dai-ichi Life Economic Research Institute in August of the same year. The current situation since April 2011.

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