Japan’s central bank has bucked the global trend for a tighter monetary policy and maintained an ultra-loose stance. However, the invasion of Ukraine, the COVID-19 pandemic and hawkish outlook of the US Federal Reserve are moving against the Bank of Japan’s stance and putting pressure on the country’s currency. The central bank is also finding it difficult to keep control of key bond yields, stoking speculation that Bank of Japan governor Haruhiko Kuroda may prop up the currency for the first time since 1998.

On Monday, the yen fell over 2 percent against the dollar to reach ¥125 as traders forecast further drops. So far this month, the yen has dropped more than 7 percent against the dollar, making this the worst month since 2016 for the Japanese currency.

Why is BoJ keeping rates low?

In general, higher interest rates tend to push the value of the country's currency higher. This is because higher interest rates attract foreign investment, thereby increasing the demand for and value of the local currency.

A strong dollar means those trading in the greenback get more when they buy goods from Japan. This could be a potential boon for the US, which is facing inflation at nearly 8 percent, The Wall Street Journal reported.

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On the other hand, Japanese manufacturers gain an edge over US competitors as the cost of products is lower in dollar terms. This has prompted Japanese policy makers to be fine with the currency moves.

“There is no change in the basic structure that a weaker yen has positive effects on the Japanese economy by pushing up the overall economy and prices," Kuroda said at a parliamentary session on Friday.

According to the report by the Bank of Japan in January, depreciation in the yen by 10 percent is likely to push up the country’s gross domestic product by about 1 percent.

Huge difference

There is a wide interest-rate differential between the US and Japanese benchmark yields. The US 10-year Treasury now yields nearly 2.5 percent, while the equivalent Japanese government bond yields 0.25 percent. On the other hand, the US two-year treasury yield is 2.3 percent, while yield of the Japanese equivalent bond is just under zero.

Considering other factors are constant, the gap between US and Japanese interest rates makes it better to hold dollars than yen as the returns are higher.

According to analysts, the yield gap is giving way to “carry trade" where investors borrow yen at low rates and convert it to dollars earning more interest, The Wall Street Journal reported.

What is the BoJ doing?

To defend its policy, the Bank of Japan offered to buy an unlimited amount of 10-year government bonds over the next three days at a price that would prevent the yield from rising further.

On Tuesday, the central bank made two offers. The first offer failed to bring down yields. Together, the offers drew bids worth 528.6 billion yen ($4.28 billion), Reuters reported.

Some analysts believe BoJ will not be able to sustain its bond-buying action for a prolonged period.

"Theoretically, the BOJ can protect 25 basis-point upper bound through unlimited fixed-rate operations. But at the same time, I think this situation is not sustainable," Reuters quoted Kentaro Koyama, chief economist at Deutsche Bank in Tokyo, as saying.

Last week, Kuroda had said that stable inflation was required for the central bank to trigger policy change and not a weak yen. As inflation remains relatively quiet in Japan, Kuroda is under little pressure to raise rates to match the US trend.

However, Japan's chief cabinet secretary Hirokazu Matsuno on Monday said the government was watching the market closely, including the recent depreciation of the yen.

(Edited by : Thomas Abraham)