The Japanese cabinet strongly supports easing, officials' verbal interventions have failed, and the battle to defend the yen is caught in a dilemma.

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The latest efforts by Japanese authorities to curb the depreciation of the yen are facing difficulties. Unlike previous governments that prioritized stable exchange rates, the new cabinet led by Prime Minister Sanae Takaichi is signaling tolerance and even welcoming a weaker yen, which has undermined the Ministry of Finance’s verbal interventions to support the currency and plunged Japan’s “yen defense war” into a policy dilemma.

The market’s skepticism has been clearly evident this week. Even though Finance Minister Satsuki Katayama warned that authorities are alert to “one-sided, sharp fluctuations” in the currency market and acknowledged that the negative impact of a weak yen is becoming more pronounced, these comments failed to stop the yen’s decline. The US dollar briefly broke through the key psychological level of 155 against the yen this week and traded near 154.50 on Friday, while the yen also hit a record low against the euro.

The reason investors are unmoved by official statements is that Takaichi’s cabinet core is packed with “reflationist” advocates of fiscal expansion and monetary easing. Reportedly, these new policy advisors openly promote the benefits of a weak yen. At the same time, both Takaichi and her finance minister have voiced dissatisfaction with the possibility of a near-term interest rate hike by the Bank of Japan, further reinforcing expectations in the market that Japan will be slow to tighten monetary policy.

With the tool of interest rate hikes constrained by political will and foreign exchange intervention facing extremely high thresholds, the policy space for Japanese decision-makers to respond to yen depreciation seems almost exhausted. This keeps the outlook for the yen under pressure and may lead to further declines in the absence of effective policy brakes.

Dovish Cabinet Weakens Effectiveness of Intervention

Conflicting signals from within the Japanese government are seriously undermining the effectiveness of its market communication. Finance Minister Satsuki Katayama’s verbal warning on Wednesday failed to take effect mainly because her wording did not escalate to more forceful statements such as “prepared to take decisive action,” which the market interpreted as a lack of determination to intervene.

Meanwhile, comments from other cabinet members have deepened market doubts even further. Last month, Economic Revitalization Minister Minoru Kiuchi said a weak yen would benefit growth. On Tuesday, he claimed that the impact of a soft yen pushing up import costs was diminishing. This stance sharply contrasts with previous governments’ focus on the pressure that imported inflation puts on livelihoods. Mizuho Securities’ chief forex strategist Masafumi Yamamoto pointed out:

“The Takaichi government’s failure to escalate its warnings indicates it is tolerating a weaker yen.”

He predicts that the Japanese government may wait until the yen drops below 155 against the dollar before escalating its verbal warnings and only consider direct market intervention if it falls below 160.

Dovish Stance Weighs on Rate Hike Prospects

Sanae Takaichi herself is a staunch supporter of “Abenomics.” Now, through key appointments, she has embedded economists who advocate low interest rates to support large-scale spending, such as Takuji Aida, into the government’s core growth strategy team. Advisors like Aida stress that a weak yen helps offset the impact of US tariffs on manufacturers.

Although yen depreciation has pushed Japan’s inflation rate above the BOJ’s 2% target for more than three years, sparking public discontent over rising living costs, the government’s dovish stance seems unwavering. Facing mounting inflation pressures, BOJ Governor Kazuo Ueda previously hinted at a possible rate hike as early as next month. However, Takaichi and the finance minister swiftly voiced displeasure, saying Japan has not yet achieved a sustained achievement of its inflation target.

This attitude directly affects market expectations for the central bank’s policy path. BNP Paribas chief Japan economist Ryutaro Kono commented:

“The Takaichi government is more inclined toward reflationary policy than initially imagined.”

Based on recent appointments and policy stances, Kono has cut his forecast for BOJ rate hikes next year from three to two.

High Bar for Intervention, Yen Outlook Under Pressure

With rate hike options blocked, forex intervention has become the only remaining tool to curb yen declines. But the bar for activating this tool is very high. Historically, Japan’s last market intervention was in July 2024, when the Kishida government stepped in as the yen fell to 161.96 against the dollar, a 38-year low, and the BOJ raised rates to 0.25% that month.

However, compared to then, Takaichi’s government faces greater challenges in terms of both the willingness and external conditions for intervention. On one hand, gaining approval from the US side may be very difficult. US Treasury Secretary Yellen has repeatedly suggested that rate hikes are the best way to support the yen.

On the other hand, there are doubts about the effectiveness of intervention within policy circles. Former BOJ official Toru Sasaki believes that intervening to buy yen while real interest rates in Japan remain deeply negative is tantamount to “wasting forex reserves.” He expects that unless the yen falls below 165, Japan will not intervene. With limited policy options, downward pressure on the yen is set to persist.

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