Japan has long sought more inflation and a weak yen. But not like this.

TOKYO – For years, as Japan sought to bolster its chronically weak economic growth, it pursued what its central bank saw as a magic formula: stronger inflation and weaker yen.

It didn’t work as expected. Inflation never hit the government’s modest target, despite falling interest rates and massive fiscal stimuli. Worker wages stagnated and growth remained anemic.

Now, Japan is suddenly getting what it wanted, but not the way it hoped.

While headline inflation remains moderate, food and energy costs are rising rapidly, a consequence not of rising demand but of market turmoil linked to the pandemic and the Russian invasion of Ukraine. And the yen hit a two-decade low against the dollar, a staggering drop of more than 18% since September that has unsettled Japanese businesses.

The twin forces are posing another challenge for the world’s third largest economy as Japan is behind other major nations in emerging from the economic blow of the pandemic. Rising prices have scared Japanese consumers accustomed to decades of stability, and the weak yen is starting to look like it will depress domestic demand rather than stimulate it overseas.

“The depreciation of the yen is attacking the weakest point in the economy,” said Takahide Kiuchi, an economist at the Nomura Research Institute who served on the board of the Bank of Japan. Households, he said, “are facing a rise in the prices of all imported goods” and “the situation is undermining consumer sentiment even before actual inflation.”

Concerns about the depreciation of the yen reflect a gradual change in the Japanese economy over the past decade.

In an earlier era, when Japan was a manufacturing superpower, a weak yen would have been a cause for celebration, making Japanese exports cheaper overseas, increasing the value of overseas earnings, and attracting foreign investment.

But export is now less important to the Japanese economy in general, and companies, trying to avoid trade restrictions and taking advantage of lower labor costs, have begun to produce more of their products overseas, reducing the impact of exchange rates on their profits.

A Bank of Japan report released in January found that while a weak yen continued to help the economy, its positive impact on exports declined in the decade leading up to the pandemic. Its contribution to inflation, however, had increased over the same period.

The pandemic and the war in Ukraine most likely amplified the negatives and diminished the positives, said Naohiko Baba, Japan’s chief economist at Goldman Sachs. of the war impact on exports of Ukrainian grain and Russian gas and oil.

For resource-poor Japan, which is heavily reliant on imports of fuel and food, the decline in the yen has pushed already high prices even higher, with the costs of some basic necessities rising by double-digit percentages. For the first time in over a decade, consumers are paying more for Asahi beer. It is a convenience store brand chicken had its first price increase in more than 35 years.

“From the point of view of exporters, the weaker yen should be beneficial, but for others it should be neutral or negative,” Baba said. He added that the potential upside in the currency devaluation was further reduced by Japan’s decision to continue excluding international tourists, who may be eager to take advantage of favorable exchange rates.

There are a number of reasons for the yen’s weakness. The Japanese economy faltered during the pandemic and skyrocketing commodity prices forced importers to sell more yen per dollar to pay their bills.

But the main cause, experts say, is Japan’s insistence on keeping interest rates close to zero even as other central banks, led by the Federal Reserve, drastically raise theirs.

The widening of the spread has triggered a rush to buy dollars as investors seek better returns. And the exodus seems destined to continue.

Last week, the The Fed raised interest rates by half a pointthe biggest leap in over 20 years, and he said he intends to continue increasing loan costs as he tries to cool rapid inflation fueled by a booming American job market and rising wages.

Wages in Japan, by contrast, were barely budgeted and the country’s high levels of employment remained relatively stable. This means that Japan’s inflation, which overall remains below the government’s 2% target, is most likely driven by supply-side problems caused by the war and the pandemic, not by increased demand that low interest rates should produce.

In theory, the Bank of Japan could block the yen’s devaluation by raising interest rates. But its governor, Haruhiko Kuroda, whose term expires next April, looks set to stick to his policies until he reaches the inflation of both quality and quantity he envisioned nearly a decade ago when he was appointed by the then Prime Minister Shinzo Abe.

Modest inflation driven by consumer demand, it is thought, would create a virtuous circle of economic expansion: corporate profits would rise, stimulating investment, wage growth and domestic consumption.

At the end of April, Kuroda doubled down on its commitment to cut rates by increasing the Bank of Japan’s purchases of government bonds. The announcement was followed by a sale of yen.

Even if Kuroda wants to raise rates, that could trigger a cascade of economic consequences, said Gene Park, a professor of political science and international relations at Loyola Marymount University who studies Japanese monetary policy.

Japan has come to rely on large spending to stimulate its economy, Park said, and rising rates could both make it more difficult to pursue that approach and make Japan’s national debt, which exceeds 250, more difficult. % of its annual economic production. service.

While the economists disagreement on whether that level of debt is sustainable, politicians are not eager to prove it.

“High inflation is politically toxic and even trying to correct it, medicine, is an extremely bitter pill,” Park said. “If they raise interest rates, that too will be unpopular.”

Like Mr. Kuroda, Prime Minister Fumio Kishida rejected suggestions that the Bank of Japan should try to strengthen the yen by raising interest rates.

Instead, it tried to fight the price increase with more stimulus. This year, Parliament signed several rounds of subsidies to Japanese oil companies that aim to lower gas prices. In April, lawmakers announced an additional round of subsidies and direct cash payments of approximately $ 380 to families with children.

Some politicians have suggested that the Bank of Japan could support the value of the yen through foreign exchange market interventions, selling its holdings in dollars to raise the Japanese currency. But this is an expensive proposition that is unlikely to have much effect, said Saori Katada, a professor of international relations at the University of Southern California who studies Japan’s trade and monetary policy.

“These days, the central bank has already given up on intervening in the market,” said Ms. Katada. “The whole market has gotten so big that the actual intervention doesn’t change it. It might change that for a few days, but it won’t change the trend. “

With few practical options, the only thing Japan can try to do is “talk about the yen,” he said, with officials doing an all-out press to convince markets that they will protect the currency’s value. However, “this requires the help of other partners in the US and Europe,” she said, and they are too busy dealing with the problems of their own economies to pay much attention to Japan.

“At the moment they don’t care too much about the depreciating yen,” he said.

That means Japan may need to hold on until things change, said Sayuri Shirai, an economics professor at Keio University in Tokyo and a former board member of the Bank of Japan.

US interest rates “will not expand forever,” he said. “I think we shouldn’t panic.”

Hisako Ueno contributed reportage.