Japan: How Much Higher Will the Yen Go?

A supercharged currency could derail a Japanese recovery. Toyota and other exporters hope for relief, but the government seems unworried

By Ian Rowley

After suffering through a year's worth of Lehman shokku ("Lehman shock"), Japan is getting back on an even keel. The Japanese economy contracted at a double-digit pace between October and March but is growing again, rising an annualized 2.3% between April and June. The Nikkei 225 stock index has stabilized at around 10,000, almost 50% higher than the two-decade lows experienced in March. And while the business community has not greeted the new Democratic Party of Japan government with high expectations, so far Prime Minister Yukio Hatoyama has at least made no major missteps.

Yet one problem that shows few signs of receding is the strength of the Japanese currency. The yen, which surged last fall in response to the economic crisis, remains stubbornly high, particularly against the dollar. In recent weeks the yen has hovered close to January's 13-year high of 87.10 to the dollar, causing market watchers to speculate that the currency could close in on the 1995 all-time high of 79.75. Daisuke Uno, chief strategist at Sumitomo Mitsui (8316.T), expects the currency to barrel its way through that barrier. He told Bloomberg News on Oct. 15 that the dollar may weaken next year to a record-setting 50 yen. "The dollar's fall won't stop until there's a change to the global currency system," Uno told Bloomberg.

Even if the yen doesn't get to that level, more strengthening would hammer Japan's ailing exporters, since economists say that an appreciation of every 10 yen cuts corporate profits by about 15%. The currency, combined with slumping demand, is a big reason Toyota (TM) expects to post losses for a second straight year. "If the yen were to go to 70, you could switch off the lights in Toyota City," says Jesper Koll, CEO of Tantallon Research Japan.

A Win for Korea's Won

Making matters worse for the Japanese, their rivals in Korea, such as Hyundai Motor and Samsung Electronics, don't have the same worries. In the last two years, while the yen has surged by more than 25% against the dollar, the won has weakened against the greenback by 20%.

As painful as the strong yen is, though, Japan's new government has so far been unwilling to take steps to weaken it. Finance Minister Hirohisa Fujii implied at a press conference Oct. 7 that the government doesn't intend to intervene in the currency markets. "We would consider taking some kind of measures if the foreign exchange market moves abnormally," he said, but "we are now at the stage of monitoring the market calmly."

What gives? One likely reason for the DPJ's inaction: Intervention by Japan alone would likely have a minimal impact. Much of the current yen strength against the greenback, for instance, stems from the weakness of the dollar worldwide. Without a clear commitment to a stronger dollar from Washington, "it's hard to think of anything the DPJ could do," says Kyohei Morita, an economist at Barclays Capital in Tokyo.

Indeed, to a large extent the new ruling party is not unhappy with the current situation. "The DPJ prefers yen appreciation," says Nomura Securities economist Takahide Kiuchi.

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