The yen's sharp fall from record highs is taking some pressure off Japanese exporters and the unpopular government, but any further weakening could threaten the country's sputtering recovery by swelling its fuel import bill.
A record trade deficit and surprise policy easing by the Bank of Japan earlier this month have combined to trigger the sharpest monthly drop in the yen in more than two years, spurring a rally in stocks of exporters, which have for years been plagued by the currency's stubborn strength.
The shrinking of Japan's current account has further shaken confidence in the yen, which used to be seen as one of the world's safe-haven currencies in times of turmoil. While few think the weaker yen will solve Japan's deeper structural problems, it is fuelling a jump in Tokyo's laggard stock market, as exports remain key in a country where domestic demand is dwindling together with its rapidly ageing population.
"With the yen off its highs and stock prices rising, there's a lot of optimism. But we're not entirely sure whether Japan will indeed smoothly head for a recovery," said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute. "We can't count on a strong recovery in Europe, while Asia faces risks of a slowdown. There is also a risk markets may unwind their very bullish bets on the US economy. That makes for a long list of uncertainties on Japan's economic outlook."
The dollar spiked at one point on Monday to around 81.661 yen, up more than 5 yen or some 7 percent since the start of the month. A one yen drop translates to a 0.6 percent increase in Japanese companies' net profit, according to Nomura Securities. Tokyo's transport equipment index, home to bellwether exporters such as Toyota Motor Corp, has powered up 28 percent so far this year, after a 21 percent drop in 2011. By comparison, the broader Topix index has gained nearly 15 percent.
To be sure, the rally in cyclical stocks has been a global one, triggered by a flood of cash from accommodative central banks, but Japanese exporters are seen as the most attractive targets after years of cost-cutting spurred by the yen's relentless rise. Topix companies are expected to post an average 51.6 percent year-on-year jump in earnings in 2012, compared with a 12.6 percent rise for S&P 500 companies, according to Thomson Reuters I/B/E/S. Despite the yen's drop to nine-month lows, the Bank of Japan remains ready to act on any signs that Japan's recovery prospects could be threatened.
It is not convinced yet that the yen's weakness will be a lasting trend. Japanese authorities spent 14.3 trillion yen ($177 billion) intervening in foreign exchange markets last year to weaken the yen, while the BOJ surprised markets earlier this month by loosening monetary policy and setting a 1 percent price goal.
"Europe's crisis is far from over. Despite recent market moves, the BOJ cannot let its guard down," said a source familiar with the central bank's thinking. Expectations that the US Federal Reserve may launch a fresh round of bond buying, also known as quantitative easing, could always shift the market's tide toward renewed dollar weakness, while Europe's debt crisis means investors could again dump riskier assets in favour of the liquid US Treasuries.
The pause in the yen's ascent is among the few positives for Prime Minister Yoshihiko Noda, who wants to keep the economy strong enough to weather much-needed tax hikes he is proposing to fix Japan's tattered finances. "Usually a strong currency is a reflection of a strong economy, a growing economy, or no deficit. We see nothing like this (in Japan)," said Nissan Motor Co CEO Carlos Ghosn on Monday. "So there is no reason for which, economically, you can justify the Japanese yen's significant appreciation against the dollar and euro over the past three years," he said.
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