Last week, the Bank of Japan made a historic decision to raise interest rates for the first time since 2007. However, rather than strengthening, the yen depreciated, touching its lowest levels against the dollar in 2022. This downward trend has also pushed the yen to long-term lows against the euro and Australian dollar, raising concerns among Japanese officials about the need for intervention to stabilize the currency's value.
The weakening yen presents a mixed bag of implications for Japan’s economy. While it benefits exporters by boosting profits through enhanced competitiveness in foreign markets, it also poses challenges for households by driving up import costs. Analysts attribute this unexpected outcome to the market's anticipation of the rate hike, resulting in an overpriced yen that depreciated following the announcement. The phenomenon underscores the complex interplay between monetary policy decisions and their impact on currency valuations.
The yen's status as the lowest-yielding G10 currency makes it attractive for carry trades, where investors borrow in low-interest currencies to invest in higher-yielding assets. In the aftermath of the rate hike, market participants have been adjusting their positions, betting on the prospect of prolonged low rates in Japan. This sentiment contrasts with the situation in the U.S., where interest rates are significantly higher, leading to a notable yield gap with Japan and encouraging Japanese investors to keep their funds abroad for better returns. Such dynamics contribute to the yen's vulnerability and lack of support from repatriation flows, dampening its strength against other currencies.