
Japan’s economic outlook remains gloomy but the yen’s future could be bright
- The combination of the pandemic, economic headwinds and tense relations with China might not seem encouraging for Japan, but appearances can be deceiving
- The yen often exhibits safe haven characteristics, trading anti-cyclically and gaining in strength when investors are downbeat
Revised data from Japan’s Cabinet Office, released last week, showed the Japanese economy grew by 1.9 per cent from April to June. That was above the median forecast of a 1.6 per cent rise expected by economists polled by Reuters, and significantly higher than the official preliminary estimate of a 1.3 per cent expansion.
Meanwhile, in China, the world’s biggest car market and a key sales area for Japanese carmakers, those same supply chain constraints helped fuel a 17.8 per cent year-on-year fall in vehicle sales in August.
Despite all this, the yen traded sideways last month. Japan’s MUFG Bank noted recently that, “the yen was close to unchanged versus the US dollar in August and initial strength on a Trade Weighted Index basis also reversed to leave the Nominal Effective Exchange Rate close to unchanged in August after a 1.5 per cent gain in July”.
As for the Bank of Japan’s Real Effective Exchange Rate (BOJ REER), MUFG Bank notes that it “has declined by 12 per cent since peaking in May 2020”.
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Looking ahead to the second quarter of 2022, MUFG Bank envisages the yen having made gains against the US dollar as well as the yuan and euro.
There are counterarguments, of course. HSBC recently suggested that while the yen “is an anti-cyclical and safe haven currency”, it is also “highly sensitive” to US central bank actions.
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Taking the view that the Japanese currency is undervalued on the foreign exchanges, HSBC expects it “to outperform many currencies going forward, but not necessarily the US dollar”.
Many will take an opposing view and feel the outlook for Japan’s economy is incompatible with yen strength. That is what makes a market.
But the key to understanding the way the yen will perform in the coming months necessitates looking beyond Japan’s own prospects. The optimism that underpinned the global reflation trade and drove yen weakness was predicated on a belief that the world economy was bouncing back from the pandemic.
That optimism has arguably faded. Although the prospects for Japan’s economy are clouded, the outlook for the yen could well be bright.
Neal Kimberley is a commentator on macroeconomics and financial markets
