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Currency Wars

Japan's Currency Dance: Weaken the Yen—But Not Too Weak

Japan's Currency Dance: Weaken the Yen—But Not Too Weak

Photograph by Akio Kon/Bloomberg

Weaken the yen: That has been a desperate plea by the captains of Japanese industry for years as the strong currency has hurt such exporters as Sony (SNE) and Toyota (TM). Reversing the yen’s rise was a major goal of Liberal Democratic Party leader Shinzo Abe during his successful campaign against incumbent Prime Minister Yoshihiko Noda last month.

Sure enough, now that Abe is prime minister, the yen has weakened. A lot. With the government promising a big new spending program and the central bank expanding its quantitative easing policy, Japan’s currency on Jan. 18 hit a two-and-a-half-year low of ¥90.10 to the dollar. Since mid-November, when the election season got underway and an LDP victory became a near certainty, the yen has weakened by 10 percent.

Strangely enough, though, Japanese officials don’t seem to be willing to take yes for an answer. With victory in their sights, they’re suddenly talking about the yen getting too weak. For instance, Koichi Hamada, an Abe adviser, told reporters on Sunday that policymakers are “working hard to raise prices and influence the yen,” but he added, “if it goes too far, it should be stopped.” This comes after Hamada last week said a yen-to-dollar level of ¥110 would be too weak. Economy Minister Akira Amari also talked about the risk of the yen getting too weak, although he later said his comments had been misinterpreted.

The signs of skittishness about the yen could be a response by Japanese policymakers to business leaders in the U.S. who criticize Abe’s weak-yen policy. An industry group that represents Detroit’s Big Three automakers has called on President Obama to retaliate against Japan for manipulating the currency. “We urge the Obama administration to make it clear to Japan that such policies are unacceptable and will be met by reciprocal measures,” said Matt Blunt, president of the Washington-based American Automotive Policy Council, in a statement on Jan. 17.

Hence the need for some spin from Tokyo. “The yen is doing what the prime minister said he wanted it to do,” says Michael Spencer, Hong Kong-based chief economist for Asia at Deutsche Bank (DB). With Abe’s advisers now talking about excess weakness, “my guess is some outside pressure is being brought to bear,” he says. That leads to officials trying to reassure the Americans and others that the Japanese “are not trying to undercut everybody.”

As they try to weaken the yen without triggering retaliation from the Americans, Japan’s policymakers have their hands full tackling the other big item on Abe’s agenda: ending deflation. At its monthly meeting on Jan. 22, the Bank of Japan is likely to endorse the new prime minister’s call for more aggressive action to bring back inflation to the world’s third-largest economy, with the central bank increasing its inflation goal, from the current 1 percent to a new target of 2 percent.

Just setting the inflation target isn’t enough, though, especially if no one believes the target is attainable. “That alone will not impress the markets,” warned Izumi Devalier, a Japan economist for HSBC (HBC) in Hong Kong, writing in a Bloomberg Brief analysis on Jan. 21.

Given the chronic deflation that has plagued Japan for years, even 1 percent inflation is a reach. The core inflation rate was in the red in November, at minus 0.1 percent. Indeed, the last time Japan had a 2 percent inflation rate was in 1997, when an increase in the value-added tax caused a short-term spike in prices. “Unaccompanied by a serious commitment by the BOJ, the proposed inflation target looks like wishful thinking, threatening the central bank’s credibility,” Devalier wrote.

So if, as appears likely, the Bank of Japan does increase its inflation target, the central bank will need to take some other action. Last month the bank committed to a ¥10 trillion ($111.6 billion) expansion of its asset-purchase program, and HSBC now expects more easing measures, most likely in the form of ¥5 trillion to ¥10 trillion in spending to expand the asset-purchase program even further.

There’s reason to be skeptical about how far and how fast the central bank will go in supporting Abe’s goals, though. The Bank of Japan “has a history of disappointing,” Mikio Kumada, a global strategist in Hong Kong for LGT Capital Partners, told Bloomberg TV on Jan. 21. “So in that sense, some caution is probably warranted.”

Einhorn is Asia regional editor in Bloomberg Businessweek’s Hong Kong bureau. Follow him on Twitter @BruceEinhorn.

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