Japan Faces Economic Recession and Yen Depreciation Dilemma
Japan's economy has slipped into a technical recession, prompting the Bank of Japan (BOJ) to navigate a challenging course between supporting the fragile growth and addressing the yen's depreciation. Sayuri Shirai, a former BOJ board member and now an economics professor at Keio University, shared insights with CNBC, indicating that the central bank is expected to exit its negative interest rate policy this spring. However, the sluggish growth limits its ability to counteract the yen's weakening.
The pressure on BOJ Governor Kazuo Ueda is mounting, with high U.S. interest rates and Japan's ultra-easy policy fueling the yen's depreciation. This comes amid concerns over high inflation rates in Japan, which policymakers view as unsustainable and a factor contributing to the country's economic downturn. Japan's unexpected economic contraction has led to it being overtaken by Germany as the world's fourth-largest economy.
Shirai highlighted the BOJ's dilemma, suggesting that despite the inflation not being driven by domestic demand sustainably, the central bank might adjust its policies, including removing negative interest rates, to mitigate side effects. The yen's value has been under significant pressure, recently retreating to around 150 to the dollar, as U.S. inflation data exceeded expectations, reducing hopes for a Federal Reserve rate cut.
The BOJ's policy adjustments are anticipated by market participants this spring, regardless of achieving a stable 2% inflation rate. Japan's economy faces a tough situation with prolonged high inflation rates impacting domestic consumption, leading to the second consecutive GDP contraction in the fourth quarter. While core inflation has been above the BOJ's target for over a year, policymakers remain cautious, maintaining short-term interest rates at -0.1% and adhering to yield curve control policies.
The market expects the BOJ to move away from negative rates at its April policy meeting, contingent on annual wage negotiations indicating meaningful wage increases. However, Shirai pointed out that both yen-denominated wages and household consumption are declining, making it difficult for the BOJ to normalize policies despite inflation rates above 2%.
The challenge lies in the interest rate differential causing the yen's depreciation, making it problematic to raise interest rates without further weakening the economy. As such, any normalization might only involve removing negative interest rates, which would have limited impact on the yen's value. Japan's central bank thus finds itself between a rock and a hard place, striving to balance economic support and currency stability.
