Japan is ready to take action to address the excessive volatility seen in the yen, the country's top currency diplomat said on Thursday, issuing the strongest warning to date after the currency plunged to 24 year lows.
Japan has several options to deal with excessive yen falls, aside from verbal intervention. One of the main reasons for this is to directly intervene in the currency market, selling dollars and buying large amounts of yen.
The sluggish slide in Japan's currency has run so far and it is spooking big investors, and some are already cutting bets that it will decline further, anticipating policymakers will try and arrest the freefall.
Below are some details about how yen-buying intervention could work, the likelihood of this happening and challenges:
Japan has taken a hands-off approach to yen falls because of the economy's heavy reliance on exports.
Yen-buying intervention has been very rare. The last time Japan intervened to support its currency was in 1998, when the Asian financial crisis caused a sell-off and a rapid capital outflow from the region. Before that, Tokyo intervened to counter yen falls in 1991 -- 1992.
Currency intervention could be costly and could be a problem due to the difficulty of influencing its value in the huge foreign exchange market.
It is one of the reasons why it is considered a last-resort move, which Tokyo would greenlight only when verbal intervention fails to prevent a free fall in the yen. The speed of yen declines, not just levels, would be a factor in the decision of the authorities on whether and when to step in.
Some policymakers say intervention would only become an option if Japan is facing a triple threat -- selling of yen, domestic stocks and bonds -- in what would be similar to the capital outflows experienced in some emerging economies.
Before entering the market, Japanese authorities usually conduct rate checks, a practice where central bank officials call up dealers asking for the price of buying or selling yen.
It's a strong sign that intervention is close. The move alone will scare market players enough to influence yen moves to their favour, according to authorities.
When Japan intervenes to stem yen rises, the Ministry of Finance issues short-term bills to raise yen, which it can sell in the market to weaken the Japanese currency's value.
If it were to conduct intervention to stop yen falls, the authorities must tap Japan's foreign reserves for dollars to sell in the market in exchange for yen.
In both cases, the finance minister will issue a final order to intervene. The Bank of Japan will act as an agent and execute the order in the market.
Yen-buying intervention is more difficult than yen-selling.
Japan's foreign reserves are at $1.33 trillion, the world's second largest after China's and likely comprised mostly of dollars. Reserves can quickly dwindle if huge sums are required to influence rates every time Tokyo steps in.
That means there are limits to how long it can keep intervening, unlike for yen-selling intervention - where Tokyo can continue issuing bills to raise yen.
Currency intervention would require informal consent from Japan's G 7 counterparts, notably the United States, if it were to be conducted against the dollar yen. It is not easy to understand how Washington is opposed to the idea of currency intervention except in cases of extreme market volatility.