The high city cabinet supports easing, and verbal intervention by officials has failed, putting the yen defense battle in a dilemma

Japan's latest efforts by authorities to curb the depreciation of the yen are struggling. Unlike previous administrations that prioritized stabilizing the exchange rate, the cabinet led by new Prime Minister Sanae Takaichi has signaled a tolerance or even welcome for a weaker yen, undermining the effectiveness of the Finance Ministry's verbal interventions aimed at supporting the yen, and placing Japan's "yen defense battle" in a policy dilemma.

The market's skepticism was evident this week. Despite Finance Minister Satsuki Katayama warning that authorities are vigilant against "one-sided and sharp fluctuations" in the foreign exchange market and acknowledging the increasingly prominent negative effects of a weak yen, these statements failed to halt the yen's decline. The dollar against the yen briefly broke the key psychological level of 155 on Monday, trading around 154.50 on Friday, while the yen against the euro also hit a record low.

Investors' indifference to officials' statements stems from their observation that Takaichi's cabinet is filled with "re-inflationists" advocating for fiscal expansion and monetary easing. Reports indicate that these new policy advisors openly promote the benefits of a weak yen. At the same time, both Takaichi and her finance minister have expressed dissatisfaction with the possibility of the Bank of Japan raising interest rates in the short term, further reinforcing market expectations that Japan will slow its tightening of monetary policy.

With the dual constraints of political will limiting the use of interest rate hikes and the high threshold for foreign exchange interventions, Japan's policymakers seem to have little room to respond to the yen's depreciation. This continues to pressure the yen's outlook and may lead to further declines in the absence of effective policy brakes.

"Dovish" Cabinet Weakens Intervention Effectiveness

The contradictory signals released within the Japanese government are severely undermining the effectiveness of its market communication. The verbal warning from Finance Minister Satsuki Katayama on Wednesday was ineffective primarily because her wording did not escalate to more deterrent expressions like "prepared to take decisive action," which the market interpreted as a lack of determination to intervene.

Meanwhile, statements from other cabinet members have further exacerbated market doubts. Minister of Economic Revitalization Minoru Kiuchi stated last month that a weak yen is beneficial for growth, and on Tuesday, he claimed that the inflationary effect of a weak yen on import costs is weakening. This rhetoric sharply contrasts with the previous government's focus on the pressures of imported inflation on people's livelihoods. Masafumi Yamamoto, chief foreign exchange strategist at Mizuho Securities, pointed out:

"The Takaichi government has not escalated its warning level, indicating that it is tolerating a weaker yen."

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

Easing Stance Weighs on Rate Hike Prospects

Sanae Takaichi is a staunch supporter of "Abenomics." Now, through key personnel appointments, she has placed economists advocating for low interest rates to support large-scale spending, such as Takuji Aida, into the core growth strategy group of the government. Advisors like Aida emphasize that a weak yen helps mitigate the impact of U.S. tariffs on manufacturers Despite the depreciation of the yen leading to Japan's inflation rate exceeding the central bank's 2% target for more than three consecutive years and triggering dissatisfaction among households over rising living costs, the government's accommodative stance seems unshaken. In the face of increasing inflationary pressures, Bank of Japan Governor Kazuo Ueda hinted that an interest rate hike could occur as early as next month. However, Prime Minister Fumio Kishida and the Finance Minister quickly expressed their dissatisfaction, stating that Japan has not yet achieved a sustainable inflation target.

This attitude from the government directly affects market expectations regarding the central bank's policy path. Ryutaro Kono, Chief Japan Economist at BNP Paribas, stated:

"The likelihood that the Kishida government favors re-inflation policies is higher than initially thought."

Based on the latest personnel appointments and policy positions, Kono has revised his forecast for the number of interest rate hikes by the Bank of Japan next year from three to two.

High Intervention Threshold, Yen Outlook Under Pressure

With the option of raising interest rates blocked, foreign exchange intervention has become the only remaining tool to curb the yen's decline. However, the threshold for activating this tool is extremely high. Looking back at history, Japan's last market intervention occurred in July 2024, when the Kishida government intervened as the yen fell to a 38-year low of 161.96 against the dollar, and the Bank of Japan also raised rates to 0.25% that month.

However, compared to that time, the Kishida government's willingness to intervene and the external conditions are more challenging. On one hand, gaining consent from the United States may be quite difficult. U.S. Treasury Secretary Janet Yellen has repeatedly hinted that raising interest rates is the best way to support the yen.

On the other hand, there is skepticism within the policy circles regarding the effectiveness of intervention. Former Bank of Japan official Toru Sasaki believes that intervening to buy yen while Japan's real interest rates remain deeply negative is akin to "wasting foreign exchange reserves." He expects that Japan will not intervene unless the yen falls below 165. In the context of limited policy options, the downward pressure on the yen is likely to persist