Japan pushes to counter Yen decline amid G7 talks

During the recent Group of Seven (G7) finance leaders' summit in Italy, Japan intensified its efforts to reverse the yen's excessive depreciation, following a jump in bond yields to a 12-year high that has failed to halt the currency's slide.

The Japanese government and central bank's coordinated effort underlines policymakers' dilemma: halting steep yen depreciation that harmsconsumption while keeping borrowing costs low to help a shaky economy. Following Japan's lobbying, G7 finance ministers restated their resolve to avoid excessive volatility in foreign currency rates in a communiqué issued following the meeting on Saturday.

Masato Kanda, Japan's senior currency diplomat, underscored the likelihood of renewed currency-market intervention, saying Tokyo is prepared to act "any time" to fight excessive yen moves. "If there are excessively volatile moves that hurt the economy, we need to take action, and doing so would be justified," Kanda explained.

Bank of Japan (BOJ) Governor Kazuo Ueda, who also attended the G7 summit, said that neither inadequate consumption nor rising bond yields would impede monetary policy normalisation. Despite a first-quarter GDP slump, Ueda believes Japan's economy is on track for a gradual recovery, with experts expecting an interest rate hike if the economy meets expectations.

Ueda refrained from commentingon the recent spike in the 10-year bond yield to a 12-year high, which was fuelled by market expectations of a tapering of bond purchases. "Our basic stance is for long-term interest rates to be set by markets," Ueda declared on Saturday.

The BOJ's recent hawkish signals have fuelled market expectations for a near-term interest rate hike or a cut in asset purchases. Although Ueda has ruled out using monetary policy to affect currency movements, he is concerned about the weak yen's impact on inflation, following the government's suspected yen-buying actions in late April and early May.

According to a Reuters survey, many economists expect the BOJ to raise interest rates in the third or fourth quarter this year. Ueda also hinted at gradual interest rate increases if inflation reaches the BOJ's 2 per cent target in the coming years. However, poor consumption and stagnating pay increases put this prognosis into question.

Service-sector inflation, which is a key indication for the BOJ, remains flat. "Services inflation probably peaked," said Junichi Makino, chief economist at SMBC Nikko Securities. "It doesn't seem like underlying inflation will accelerate towards 2 per cent."

Given these economic concerns, some analysts are wondering whether the BOJ may reduce its bond-buying operations to slow the yen's slide. Despite ruling out bond purchases as a monetary policy instrument, markets are closely monitoring the BOJ's activities for signs of tapering.

Some analysts believe the BOJ will announce a cut in bond purchases as soon as the next policy meeting in June. On Friday, market expectations of a near-term tapering drove the benchmark 10-year Japanese government bond yield to a 12-year high of 1.005 per cent. However, this yield increase has not considerably boosted the yen, which stood at 156.98 to the US dollar on Friday.

"While markets appear excited about the possibility of a policy shift, the BOJ is probably cool-headed about everything," said Daiwa Securities chief market analyst Mari Iwashita, who doubts a taper decision in June. "Besides, there's no guarantee such action could stop the yen's fall."

(With inputs from Reuters)