Yen drops to lowest level against dollar since 1986
On June 29, the USD/JPY exchange rate nearly hit 162 in overseas markets, marking the weakest point for the yen since 1986, about 39 years ago.
Following the coordinated intervention by the major economies under the September 1985 Plaza Accord, the dollar weakened sharply against the yen, with USD/JPY falling from around 240 to around 150 by the time the Louvre Accord was signed in 1987. It was during this process that the level noted above was recorded. As the chart reveals no prominent support levels, a break beyond this point could cause an acceleration of the yen's decline.
The Japanese government is thought to have drawn a line in the sand around 160. But in a worst-case scenario where the yen's downswing gathers momentum, it could be forced to retreat to the 170 level.
Positive recent developments in the Middle East and falling crude oil prices are likely to be supportive of a reversal of the yen's decline. On the other hand, the fading impact of the government's forex intervention during the Golden Week holidays, coupled with the emergence of expectations for further Fed rate hikes in the US, are weighing on the Japanese currency.
Following the coordinated intervention by the major economies under the September 1985 Plaza Accord, the dollar weakened sharply against the yen, with USD/JPY falling from around 240 to around 150 by the time the Louvre Accord was signed in 1987. It was during this process that the level noted above was recorded. As the chart reveals no prominent support levels, a break beyond this point could cause an acceleration of the yen's decline.
The Japanese government is thought to have drawn a line in the sand around 160. But in a worst-case scenario where the yen's downswing gathers momentum, it could be forced to retreat to the 170 level.
Positive recent developments in the Middle East and falling crude oil prices are likely to be supportive of a reversal of the yen's decline. On the other hand, the fading impact of the government's forex intervention during the Golden Week holidays, coupled with the emergence of expectations for further Fed rate hikes in the US, are weighing on the Japanese currency.
Tight government-BOJ coordination to halt yen’s decline unlikely
Although currency market intervention by the government has only a temporary impact and can do little more than buy time, close coordination by the government and Bank of Japan to arrest the yen's slide would likely stabilize the exchange rate to some extent.
However, Prime Minister Sanae Takaichi made comments during the February Lower House election that emphasized the benefits of a weak yen. This led some to conclude that she is not particularly interested in halting the yen's decline. Meanwhile, Ms. Takaichi is thought to be opposed to BOJ rate hikes, based on the belief that they would depress economic activity and offset the positive effects of the government's economic stimulus.
For this reason, tight coordination between the government (forex intervention) and BOJ (rate hikes) to prevent further weakness in the yen seems unlikely under the current administration. I suspect financial markets are well aware of this point.
However, Prime Minister Sanae Takaichi made comments during the February Lower House election that emphasized the benefits of a weak yen. This led some to conclude that she is not particularly interested in halting the yen's decline. Meanwhile, Ms. Takaichi is thought to be opposed to BOJ rate hikes, based on the belief that they would depress economic activity and offset the positive effects of the government's economic stimulus.
For this reason, tight coordination between the government (forex intervention) and BOJ (rate hikes) to prevent further weakness in the yen seems unlikely under the current administration. I suspect financial markets are well aware of this point.
Vicious cycle of weak yen and rising prices has had major impact on Japan’s economy and financial markets
USD/JPY, which stood around 115 at the beginning of 2022, moved sharply higher (indicating a weaker yen) as the Fed rapidly hiked rates to curb inflation following the COVID-19 shock. By contrast, the Bank of Japan did not move to raise rates until much later, in March 2024. I believe it was the Bank's continuation of extraordinary monetary accommodation for an extended period and its decision not to promptly raise rates in response to the COVID shock that allowed the yen to fall as far as it has.
Since 2022 the yen has weakened and prices have risen in a mutually reinforcing manner. This has had a major impact on Japan's economy and financial markets, squeezing households while sending stock prices higher. A weaker yen lifts import prices and fuels inflation, while the resulting inflation drives the yen lower by reducing the value of the currency.
Since 2022 the yen has weakened and prices have risen in a mutually reinforcing manner. This has had a major impact on Japan's economy and financial markets, squeezing households while sending stock prices higher. A weaker yen lifts import prices and fuels inflation, while the resulting inflation drives the yen lower by reducing the value of the currency.
Resolving excessive weakness in yen will take a long time
The Bank of Japan is currently in the process of raising interest rates, but it will probably take time for the vicious cycle of a falling yen and rising prices to wind down now that it has come this far. Food price inflation cooled early this year, and there were signs that the trend of yen weakness and rising prices was losing momentum, but that was interrupted by the surge in crude oil prices.
The impact of higher oil prices on the general level of prices is likely to remain significant until around the end of 2026, with a pronounced decline in inflation unlikely until 2027. The downward trend in the yen may therefore remain in force through the end of this year.
That said, I expect the vicious cycle of yen weakness and rising prices to begin gradually winding down starting next year. Continued rate hikes by the Bank of Japan should also be supportive of this trend.
If we consider the 10-year moving average of the yen's real effective exchange rate to represent an equilibrium of sorts, the currency is now trading around 25% below that point. From this perspective, one guideline for the equilibrium level for USD/JPY would be the area around 120.
I think USD/JPY could eventually correct to around 120, but even if it does, it could take four to five years. For now, any significant correction in the pair is likely to be a correction of dollar strength rather than yen weakness. Factors that could bring this about include weakness in the US economy, diminished expectations for Fed rate hikes due to political pressure, and an end to the AI boom in the stock market.
The impact of higher oil prices on the general level of prices is likely to remain significant until around the end of 2026, with a pronounced decline in inflation unlikely until 2027. The downward trend in the yen may therefore remain in force through the end of this year.
That said, I expect the vicious cycle of yen weakness and rising prices to begin gradually winding down starting next year. Continued rate hikes by the Bank of Japan should also be supportive of this trend.
If we consider the 10-year moving average of the yen's real effective exchange rate to represent an equilibrium of sorts, the currency is now trading around 25% below that point. From this perspective, one guideline for the equilibrium level for USD/JPY would be the area around 120.
I think USD/JPY could eventually correct to around 120, but even if it does, it could take four to five years. For now, any significant correction in the pair is likely to be a correction of dollar strength rather than yen weakness. Factors that could bring this about include weakness in the US economy, diminished expectations for Fed rate hikes due to political pressure, and an end to the AI boom in the stock market.
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Takahide KiuchiPortraits of Takahide Kiuchi
Executive Economist
Takahide Kiuchi started his career as an economist in 1987, as he joined Nomura Research Institute. His first assignment was research and forecast of Japanese economy. In 1990, he joined Nomura Research Institute Deutschland as an economist of German and European economy. In 1996, he started covering US economy in New York Office. He transferred to Nomura Securities in 2004, and four years later, he was assigned to Head of Economic Research Department and Chief Economist in 2007. He was in charge of Japanese Economy in Global Research Team. In 2012, He was nominated by Cabinet and approved by Diet as Member of the Policy Board, the committee of the highest decision making in Bank of Japan. He implemented decisions on the Bank’s important policies and operations including monetary policy for five years.
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