Yen even weaker than figures show

TOKYO: The yen’s slump to a five-year low against the dollar last week seized the attention of financial markets, but the dramatic headlines didn’t even capture the full extent of its weakness.

The Japanese currency also slid to a record low based on a JPMorgan Chase index that measures it against those of Japan’s major trading partners and is adjusted for inflation. The decline in the real effective exchange rate has been driven by the yen’s falling nominal exchange rates, and the fact that inflation is slower in Japan than in most other economies.

The yen has fallen out of favour on signs that the Bank of Japan is lagging behind its global peers in normalising monetary policy due to a sluggish economic recovery. The currency has also dropped as the global recovery from the pandemic — though uneven — has sapped demand for safe-haven assets.

While the US Federal Reserve and Bank of England announced aggressive steps last month to pull back from their highly accommodative policy settings, the BoJ said it would stick to its more cautious approach due to uncertainties about Covid and the omicron variant.

The annual US inflation rate jumped to a four-decade high of 6.8% in November, whereas a similar gauge of price growth in Japan has remained below 1% since late 2018.

Still, Japan’s falling real effective exchange rate may lead to higher domestic goods prices, which will then start to feed speculation that the central bank will shift toward policy normalisation and bolster the yen, said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank in Tokyo.

The cheap yen may also help prompt a return of some factories to Japan from abroad, which could also underpin the currency, she said.

The yen reached a five-year low of 116.35 per dollar last Tuesday before recovering slightly to 115.95 on Thursday. Sera says it could strengthen to as much as 105 later this year, but others see room for deeper declines.

“We still think the interest-rate differential story will be the key driver here with US yields rising further and pushing down the yen more,” said Marcel Thieliant, a senior economist at Capital Economics in Singapore.

The currency is set to weaken to 120 per dollar this year even though the decline in the real effective exchange rate may limit some of its downside, he said.