The yen's decline to nearly 40-year lows reflects the Bank of Japan's inflationary monetary policy, not concerns about the country's public finances, according to a report from BCA Research.
BCA expects the yen and Japanese government bonds to remain under pressure until the end of 2026, but the company's analysts recommend investors prepare to buy the significantly undervalued currency this winter.
The company believes that traditional interest rate differentials no longer explain the yen's weakness. Inflation expectations and the relative steepness of Japan's yield curve provide a more compelling explanation for recent movements in the USD/JPY and EUR/JPY pairs.
Japan's real policy rate is minus 0.75%, which BCA characterized as an extremely accommodative stance amid signs of economic overheating. Annual wage negotiations have resulted in increases of over 5% for three consecutive years, and credit growth reached 5.7% in June—the highest rate in more than 30 years outside the pandemic period.
The BCA forecasts headline inflation in Japan to reach 2.7% by June 2027, with core inflation rising to 3.1%. Such growth could ultimately force the Bank of Japan to adopt a tighter stance, which would support the yen and flatten the Japanese yield curve.
Low volatility in the foreign exchange and bond markets has also stimulated the carry trade in yen financing, increasing selling pressure. Significant speculative short positions create a growing risk of a sharp reversal in the event of increased volatility or government intervention.
The BCA recommended maintaining a below-market position in Japanese government bonds until the end of the year and accumulating yen during the winter. The company also replaced its short position on USD/JPY, which it closed at a 1.4% loss, with a short position on CHF/JPY.
The company moved Japanese banks to a neutral stance. Rising yields supported bank profitability, but a future shift in the Bank of Japan's policy could flatten the yield curve and reduce interest margins.
The BCA noted that Japan's high government debt does not represent an immediate fiscal crisis, citing the country's current account surplus, significant foreign assets, and declining net debt-to-GDP ratio.