The yen plunges: a dilemma for the boj?
The Japanese yen depreciated sharply at the end of March, falling below JPY 120 to the dollar for the first time in seven years. A key part of Abenomics, a reflation strategy launched in 2012, was based on the economic support provided by a weaker yen. The Japanese currency fell already sharply between September 2012 and May 2015 (see chart 2). Although this seems to have bolstered economic growth (the output gap has narrowed in recent years), the strategy may have reached its limits in the current situation. The major divergence between US and Japanese monetary policies is leading to a decline in JPY purchases. A weaker yen amplifies the increase in import prices, which are already very high, adding to inflation and the erosion of household purchasing power. The Bank of Japan is thus faced with a dilemma: it can maintain the status quo with its policy of controlling interest rates (which is very accommodating, but which is likely to extend the yen’s decline) or proceed with a policy adjustment (halting the yen’s depreciation, but at the cost of less advantageous borrowing conditions). It is anticipated that the BoJ will raise the yield cap, currently at 0.25 for 10-year bonds.
Inflation should accelerate sharply in April, approaching or even exceeding the BoJ target rate of 2%. This increase can be attributed to three factors: (1) a base effect on telephone rates (which dropped by nearly 40% in April 2021); (2) higher energy costs, which will have a more lasting impact on inflation throughout 2022; and (3) pricing pressures on other spending items (notably food products), which will pick up gradually. It remains to be seen whether Japanese companies will be able to absorb these higher production costs and limit the pass-through to sales prices. Japanese companies still benefited from high margins in 20211, but they will have to cut them more drastically this year.
