Yen at risk of being dragged down by Japan’s sputtering exports

The yen has room to weaken further as Japan’s deteriorating international trade position adds to pressure to maintain a softer currency, potentially hindering the Bank of Japan’s scope to battle inflation with tighter monetary policy.

The Japanese currency has already slumped more than 7% since mid-January, reversing the bulk of the gains it made after the BOJ officials in December tweaked their yield curve control policy tools and spurred speculation about potential benchmark rate hikes.

Part of yen’s move is a dialing back of expectations for the BOJ and part is an increase in bets on US tightening, which has lifted the dollar. But underlying it also is a trade deficit that is, thanks to sputtering exports, still ballooning despite a slide in commodity prices.

Energy and agricultural prices may be down, but activity in some of Japan’s biggest export sectors is struggling. Auto and semiconductor equipment production in the nation slowed markedly in January, according to data released Tuesday.

The competitive landscape is only getting tougher, especially in a world that’s seen many trade barriers increase over recent years. China and South Korea, two of Japan’s major rivals in automotive exports, have also see significant drops in their currencies. To keep pace, Japan may need to be conscious of how strong its currency is, which could in turn put a lid on how high the BOJ is willing to lift its policy benchmarks. That could exacerbate domestic inflation pressures.

In the meantime, the outlook for Japanese exports appears grim. Earlier this month, figures for January showed a record trade deficit for the nation, while export growth fell 3.5% month-on-month, reflecting the impact of slowing economic growth globally.

Overseas shipments of cars made in China, by comparison, have tripled since 2020 to reach more than 2.5 million last year, according to data from the China Passenger Car Association. That’s behind Japan, though ahead of the US and South Korea.

At the same time, the outlook for the US, a major destination for exports, remains unclear. Recent data from the world’s largest economy suggest a degree of resilience, but that also risks pushing the Fed to tighten even further, which in turn could not only undermine global growth, but also put additional upward pressure on the dollar — and downward pressure on the yen.