Bank of Japan (BoJ) – intervention in the foreign exchange market
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The Bank of Japan’s ultra-loose monetary policy is under pressure from a large group of global central banks that are embarking on a series of interest rate hikes and balance sheet reduction programmes. While many central banks, including the Federal Reserve (Fed) and the Bank of England (BoE), are trying to navigate a difficult path to suppress rampant inflation while leaving their economies with enough liquidity to grow, the Bank of Japan has a different set of problems, namely anemic growth and inflation. which is constantly below target. As interest rate differentials widen between Japan and other major economies, the Japanese yen continues to weaken. And the Bank of Japan is not standing idly by and letting this happen, it seems to be actively encouraging the move.
Interest rates and the forex market
The benefits of a weaker currency
A weaker currency, compared to its peers, helps boost a country’s export sector by making its goods more competitive than its competitors. These additional sales, in turn, help boost economic growth, the labor market and countries’ balance of payments. A weaker currency also makes imports more expensive, which leads to higher inflation. By moving its currency higher or lower, a country can help steer its economy toward the desired landing zone without having to resort to domestic punitive fiscal measures.
Central Banking and Monetary Policy: How Central Banks Set Policy
While in theory moving the currency to suit domestic politics seems economically prudent, currency manipulation is frowned upon, particularly by one’s largest trading partners. The US Treasury Department has a set of guidelines for what it considers currency manipulation, and if those principles are met, the US will cooperate with the country in question to eliminate the unfair competitive advantage that such manipulation has created. If all else fails, the United States could invoke trade sanctions against the counterparty.
History of Bank of Japan intervention
The Bank of Japan has actively intervened in foreign exchange on numerous occasions since the Japanese yen was floated against the US dollar in 1973. The central bank has intervened repeatedly over the past 25 years to either keep the currency attractive to help exporters or to try and weaken the currency to promote growth and inflation. The Bank of Japan introduced quantitative easing in the early 2000s in an effort to increase inflation by offering to buy huge amounts of government bonds at set interest rates. The program has been upgraded on numerous occasions to increase the number of bonds the central bank will buy, adding asset-backed securities to the mix and then including stocks in the basket of assets the Bank of Japan will buy. The Bank of Japan is currently the largest holder of Japanese stocks, across several ETFs, and owns about 50% of the Japanese bond market.
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The monthly USDJPY price chart shows a series of sharp long-term reversals in the currency pair when the Bank of Japan changes the course of monetary policy.
USD/JPY monthly price chart
Source: ProRealTime.com
Talking about the ups and downs of the Japanese yen
As with other central banks, market communication is an essential and powerful tool the Bank of Japan uses to guide the value of the yen. As the currency approaches a certain level, the Bank of Japan becomes more vocal about what level it would be comfortable with. If the currency becomes too expensive for the BOJ, they will try to “talk it softly,” while if the currency is too low, they will let the market know about it by “raising the currency.” For a bank to be effective at talking the currency up or down, it must have market credibility or a history of backing up its views with concrete action. The monthly chart shows that the 125.00 level has held for nearly two decades as the market was seen as the BoJ line in the sand. This level is now broken.