Japan Faces Uphill Battle in Curbing Yen's Rise

By ALEX FRANGOS And ANDREW MONAHAN

A combination of Chinese buying and continued weakness in the U.S. has sent the yen to its highest level in eight months, threatening the Japanese economic recovery and frustrating government and company officials who have few tools to prevent the currency's rise.

Finance Minister Yoshihiko Noda strengthened the rhetoric on Wednesday, saying the yen's "current movement is a little one-sided." He also promised to "monitor" yen exchange rates "more closely." Mr. Noda's words did little to weaken the Japanese currency. Only better economic data out of the U.S. interrupted the gains.



Mr. Noda and his counterparts have little ammunition to halt the yen's rise. The strong yen could challenge Japan's tepid economic recovery because a pricey currency makes its exports—a key driver of its growth—more expensive on the global market.



"Even if the Japanese government tries to do something, the effect would be quite limited," says Shigeharu Suzuki, chief executive of Daiwa Securities. He calls the strong yen "a headache" and a "tough, negative factor" for Daiwa as it tends to dampen demand for overseas investment products it sells Japanese investors. He thinks the dollar in the range of 90 yen to 100 yen would be "reasonable.


.The yen's 8.7% rise against the dollar began in early May and was fueled by the Japanese government's statement that China, the world's largest foreign currency player, has been rapidly accumulating Japanese government bonds this year.

Inflation Fear Raises Spectre of Interest Rates at 3%. Access thousands of business sources not available on the free web. Learn More.Through May, China had accumulated 1.27 trillion yen, according to the Japanese government, dwarfing its purchases in previous years. That has prompted private investors to follow suit, driving up demand for Japanese bonds.


The currency superpower— with $2.5 trillion worth of reserves—could shift only 1% of its assets into yen and that would equal a month of Japan's current account surplus, a major factor for the yen's long-term strength.



The dollar fell to 85.32 yen in Japan early Wednesday before rebounding in New York to 86.30 yen. The U.S. currency may be heading towards its lowest level in 15 years against the yen. Some even see the potential for the dollar to revisit its post-Second World War low of 79.75 yen, a level reached in April 1995.



Simon Flint, global head of foreign exchange strategy at Nomura in Singapore, says it has been easy for China and other investors to pile into yen because global investors have shied away from the currency for years, meaning they have little in their portfolios already.

Fueling the yen's rise has been a confluence of factors. A report that the U.S. Federal Reserve could increase its quantitative easing program to fight off a slowdown in the U.S. economy sunk U.S. interest rates to near record lows. That has pushed the difference between U.S. Japanese rates to the smallest level in years, giving little incentive for investors to prefer dollars over yen.

Finance Minister Mr. Noda's sharpened rhetoric coincided with pleas from Japanese manufacturers being threatened by a strong yen.

"With the current rate...there would be an impact on our orders for export," Toshiyuki Shiga, Nissan Motor Co.'s chief operating officer, said. "I hope each country will cooperate to minimize the impact of the yen's strength, and I hope the [Japanese] government will make such efforts."

One step the Japanese may make is to drive long-term interest rates lower, a step that in theory could weigh on the yen by making it a more attractive funding currency, a status that would involve its being sold by international investors.

"People in the market are now looking more closely at the possibility that the Bank of Japan could take further easing measures," Yuichiro Harada, a senior vice president in Mizuho Corporate Bank's forex division, said.
It isn't clear that would weaken the Japanese currency much, however, as U.S. interest rates are expected to remain low too. The Bank of Japan tried a similar tactic last December that had only a limited effect on the yen's strength.

Another tactic would be to directly intervene in currency markets by selling yen and buying dollars, something Japan hasn't done since 2004. Market intervention could be difficult this time around as the world's developed economies have been committed to allowing market forces to direct currency levels. And it usually takes international coordination to make currency intervention successful over the longer term.

Japan could find it difficult to intervene from a diplomatic standpoint. Japan has supported the U.S. efforts to get China to liberalize its heavy handed currency policy. Turning around and intervening in markets to weaken the yen would go against the argument that markets should be allowed to set currency levels.
The U.S. economy benefits from the recently weaker dollar, which makes its exports cheaper and helps President Barack Obama's goal of doubling exports by 2015.
For this reason, "the Japanese government thinks they can't conduct intervention without the approval of the U.S.," said Chotaro Morita, head of Japan fixed income strategy research at Barclays Capital.

Write to Alex Frangos at alex.frangos@wsj.com and Andrew Monahan at andrew.monahan@dowjones.net