TOKYO – The yen's decline to around 162 against the dollar, a level not seen since 1986, is forcing a reckoning for the Bank of Japan. The monetary machinery that Tokyo began assembling four decades ago to revive a stagnant economy has become a source of instability, threatening to accelerate the currency's slide and rattle global markets.
The yen has already fallen 3.8% this year, and traders are questioning whether 170 or even 200 per dollar is possible. Jordan Rochester, a strategist at Mizuho Bank, notes that the yen "no longer trades like a G10 currency", reflecting a fundamental shift in how global investors view Japan.
The Origins of the Monster
The modern yen's DNA was forged in the mid-1980s. After the 1985 Plaza Accord sent the currency soaring, Japan's economy slipped into recession. The BOJ responded with aggressive easing, inflating an asset bubble that burst around 1990, ushering in the lost decade. Policymakers then layered fiscal and monetary stimulus—zero rates in 1999, quantitative easing in 2001—creating a system that became increasingly difficult to control.
The decisive moment came in 2013 under then-Governor Haruhiko Kuroda, who launched "quantitative and qualitative easing" (QQE). This was the monetary equivalent of the lightning bolt that brought the creature fully to life. Now, the BOJ's balance sheet—which exceeded the size of Japan's $4.2 trillion economy in 2018—remains bloated, and the central bank still holds most of the government's outstanding debt and is the largest owner of Tokyo stocks via ETFs.
Prime Minister Sanae Takaichi, who took office in October, has outlined a growth plan reminiscent of her mentor Shinzo Abe: she wants the BOJ to maintain accommodative policy while she pursues fiscal expansion, including consumption tax cuts. Bond traders are skeptical. In May, Japanese government bond yields rose to 2.8%, their highest in 29 years, reflecting concerns about Tokyo's debt load—between 240% and 260% of GDP—amid a shrinking population.
Stagflation is compounding the problem. Japan's growth rate this year is just 0.5%, while the BOJ's own inflation gauge reads 2.8%. Udith Sikand, an economist at Gavekal Research, says markets perceive the BOJ as "behind the curve on inflation."
The yen-carry trade, where investors borrow cheaply in Japan to fund bets elsewhere, amplifies the currency's moves globally. Sharp yen fluctuations now ripple through bonds and stocks far out of proportion to Japan's economic size. Between April and May, Tokyo spent more than 11.7 trillion yen ($72.8 billion) from foreign reserves to prop up the currency, yet the slide continues.
Robin Brooks, an economist at the Brookings Institution, argues that intervention is counterproductive. "To avoid a debt crisis, the Bank of Japan caps bond yields, which keeps the government's interest burden manageable," he says. "But this means that risk premia aren't reflected in bond yields. Interest rates are too low versus the risk of crisis in the eyes of markets." That, he adds, "puts depreciation pressure on the yen, since investors have little incentive to stay in Japan."
Brooks concludes: "FX intervention is deeply counterproductive because it creates the illusion that nothing's wrong when, actually, there's a very serious crisis brewing."
The BOJ under Governor Kazuo Ueda did raise short-term rates last month to a 31-year high of 1%, but it also eased up on quantitative tightening, holding monthly bond purchases at roughly 2 trillion yen ($12.5 billion). This suggests Tokyo remains reluctant to fully normalize policy. As the strong dollar continues to pressure Asia's currencies, Japan's predicament stands out. The BOJ's monetary monster, built over decades, is now turning on its maker.
