2010.08.2704:24:00UTC+00Japan Yen Intervention Talk Heats Up As Deflation Persists

Japan Prime Minister Naoto Kan is to speak later today on his policies to overturn the rapid rise in the yen and fight deflation, as political pressure rises on his government to act decisively and kick start the economy.

Observers are speculating that Kan may announce a direct intervention in the currency market to reduce the value of the yen, after Finance Minister Yoshihiko Noda was quoted as saying on Friday that the nation's currency situation is "severe." The yen hit a 15-year high against the U.S. dollar this week, sending the Nikkei index below the 9,000 level.

Japan has not intervened in the foreign exchange market since early 2004, when it brought to an end a 15-month selling spree during which it sold a total of JPY 35 trillion to reverse the rising yen. A direct intervention will almost surely spark condemnation from Japan's G7 partners just when they are calling on China to let its yuan appreciate more freely.

But many analysts say a direct intervention will be ineffective since the driving force behind the yen's rise is increasing nervousness over the U.S. recovery. The most likely government intervention, according to observers, could be more monetary stimulus measures via the Bank of Japan.

"We suspect that the government will settle for a policy of attempting to offset the impact of yen strength by targeted fiscal measures, such as subsidies for small exporters, and further policy stimulus to boost domestic demand," economists at Capital Economics said this week. "This will not stop the yen from rising and might even be seen as clearing the way for further appreciation, but it could limit the damage."

Exports have been the primary engine of Japan's recovery from the global financial downturn and officials fear a rising yen will make exports less competitive in overseas markets, plunging the economy back into recession. Latest figures showed the Japanese economy had stagnated, edging up 0.1% between April and June.

Weakening exports are not the only problem facing Japan's government. Inflation data released today showed that consumer prices fell 1.1% in July, the 17th straight month of decline. Slumping prices discourage people from spending in the long-term.

The Bank of Japan has already unveiled a $33.5 billion loan scheme to commercial banks under which it will offer one-year loans at 0.1% interest, in a bid to boost lending and encourage people to spend. But critics say the government has not acted decisively enough to turnaround the deflationary slump.

Kan's political foothold is also under threat from Ichiro Ozawa, a popular power broker in Japanese politics, who announced on Thursday he will run in ruling party's leadership election next month. Analysts say the move could further destabilize an already under-fire ruling government.

Japan received an inkling of good news on Friday, as the country's unemployment rate edged down to 5.2% in July from 5.3% in June, better than expectations for no change. Figures also showed that household spending fell by 0.4% month-on-month in July, following a 2.9% increase in June.

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