LONDON (Reuters – This week, the Japanese yen has fallen to levels last seen against the U.S. Dollar in early 2002.

It has had repercussions on the national economy. The yen-based import prices are increasing at a record pace each year, adding pressure to household balance sheets.

Friday’s rare joint statement by the Bank of Japan, and Japan’s government suggested that they might intervene if there is any weakness.

Although the impact of weakening the yen on broader financial markets has been limited, that may change if there is a rapid sell-off.

Here are some key questions regarding the implications of a sliding Japanese yen for Japan’s economy as well as international markets.

WHY DOES THE YEN FEEL WEAK?

After starting at 115 in 2022, the yen is trading near 134 for each dollar. The dollar has risen 16% this year. This is the largest annual decline since 2013.

This weakness is primarily due to widening differences in interest rates between Japan and other countries.

While most of the rest, including the U.S. Federal Reserve is increasing rates aggressively in an effort to control soaring inflation and the rest, are doing so, the BOJ has increased its easy-going policy approach.

The gap between Japanese 10-year bond yields on Japanese government bonds and US yields on Japanese 10-years has reached 279 basis points, a level that is almost 3-1/2 years high. However, the gap with German yields stands at 8-year records.

WILL THE AUTHORITIES INTERVENE?

They definitely say so.

Japan’s central bank, government, and government spoke out on Friday about the sudden sharp falls. It was their strongest warning that Tokyo may intervene.

Although the yen has quickly recovered from two decades of lows, not all believe that intervention will be possible.

Japan’s dependence on exports has meant that it has always focused on halting sharp rises in yen and taking a more hands-off approach towards yen weakness. This is because yen buying requires Japan to have limited foreign reserves.

Japan last intervened in support of its currency during the Asian financial crisis, which triggered rapid capital flight from the region. In 1991-1992, Tokyo intervened in order to stop yen falling.

It is expensive to intervene in currency markets.

HOW CAN YOU STOP THIS DECLINE

The BOJ could see a marked increase in growth as it reopens its borders after COVID. Inflation may also improve the BOJ’s outlook.

Japan’s core consumer price indexes in April was 2.1% higher than one year before, which exceeded the BOJ’s 2% inflation target. This is the highest level in seven years.

Francesca Fornasari (head of currency solutions for Insight Investments) stated that “the yen could fall if the BOJ changes tack and becomes hawkish.”

A relief rally might be triggered by any sign that the rates in Japan have surpassed their peak. Futures market data shows that the U.S. rate will peak at 3.5% by 2023.

IS A WEAKERYEN ABLE TO IMPROVE THE ECONOMY’S PERFORMANCE?

The yen fell back to its 7-year-old lows, and it is currently at new multi-year lows in relation to the Korean won or the Taiwanese currency. This will help alleviate Japan’s growing trade deficit.

John Vail is the chief global strategist for Nikko Asset Management. He believes currency weakness will be crucial to Japan’s economic competitiveness and its ability to diversify supply chains.

Foreign investors consider the Japanese stock market undervalued and are therefore more attracted to it by its declining yen. Although Japanese stocks outperformed their counterparts by 2022, they remain down because investors worldwide dump higher-risk assets.

What does it mean for FX Markets?

For investors who want to make carry trades (or borrow in low yielding currencies such as the yen) in order to get higher-yielding currencies, like U.S. dollars or Canadian dollars, the yen is the preferred currency.

According to data from Refinitiv, a strategy that borrows in yen while investing in equal amounts of U.S. dollars, Australian, and Canadian dollar would yield 13% by 2022.

Investors are worried about the speed with which the Japanese yen is falling and the question of whether policymakers will intervene, particularly if they have made short-term bets to keep the yen from reaching six-month highs.

Additional volatility and weakening could make it less attractive as a fund currency.

What is the deal with domestic investors?

Japanese investors find themselves in an awkward spot due to weakness of the Japanese yen.

International bonds have become more desirable because they offer higher yields and are on the rise. However, this also means that FX hedge costs are rising.

Japanese investors often get higher yields when they invest in foreign bonds without hedging.

Investors find it difficult to accept currency risks such as an appreciation of the yen, with the yen at so low levels. A modest return to the 115-120 level, 4 months ago would negate years of potential yield advantages.