The Bank of Japan conducted a rate check in apparent preparation for monetary intervention, the Nikkei website reported on Wednesday, citing unidentified sources, as policymakers stepped up warnings of steep declines in the yen.
Besides verbal intervention, Japan has several options to stem the excessive falls of the yen. Among them is to intervene directly in the currency market and buy large amounts of yen.
Below are details on how the yen buy intervention could work, the likelihood of it happening as well as the challenges:
WHEN DID JAPAN LAST CONDUCT A YEN BUY INTERVENTION?
Given the economy’s heavy reliance on exports, Japan has historically focused on halting strong yen rises and has taken a hands-off approach to yen declines.
Interventions to buy yen were very rare. The last time Japan stepped in to support its currency was in 1998, when the Asian financial crisis triggered a massive sell-off in yen and a rapid outflow of capital from the region. Before that, Tokyo intervened to counter the fall of the yen in 1991-1992.
WHAT WOULD INVITE TOKYO TO BUY YEN AGAIN?
Currency intervention is costly and could easily fail given the difficulty of influencing its value in the huge global foreign exchange market.
This is one of the main reasons why it is considered a last resort decision, that Tokyo would only give the go-ahead when verbal intervention fails to prevent a free fall in the yen. The speed of the yen’s decline, not just the levels, would be crucial in deciding whether or not to intervene and when.
Some policymakers say intervention would only become an option if Japan faced a ‘triple’ threat of selling yen, stocks and domestic bonds in what would be similar to the sharp capital outflows experienced by some emerging economies.
HOW WOULD IT WORK?
When Japan intervenes to stem the rise of the yen, the Ministry of Finance issues short-term bills to increase the yen which it can then sell in the market to weaken the value of the Japanese currency.
If he were to intervene to stop the fall of the yen, the authorities would have to tap into Japan’s foreign exchange reserves to obtain dollars to sell on the market in exchange for the yen.
In both cases, the Minister of Finance will give the final order to intervene. The Bank of Japan will act as agent and execute the order in the market.
WHAT ARE THE CHALLENGES?
Intervention to buy yen is more difficult than to sell yen.
Japan’s foreign exchange reserves stand at $1.33 trillion, the largest in the world after China’s and likely made up mostly of dollars. Although plentiful, reserves could quickly dwindle if huge sums are needed to influence rates whenever Tokyo steps in.
This means that there are limits to how long it can intervene, unlike the yen sell intervention where Tokyo can continue to issue bills to raise the yen.
Currency intervention would also require the informal consent of Japan’s G7 counterparts, notably the United States, if it were to be conducted against the dollar/yen. It’s not easy with Washington traditionally opposed to the idea of monetary intervention except in times of extreme market volatility.
Category: Japan
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