Recently, I observed a market phenomenon worth paying attention to. When USD/JPY approached the psychological level of 160 last year, it reflected not only exchange rate issues but also revealed a deeper dilemma regarding the outlook for the Japanese yen.

At that time, tensions in the Middle East suddenly escalated, negotiations between Iran and the U.S. broke down, and the U.S. military announced a maritime blockade of Iranian ports. This directly caused WTI crude oil prices to surge over 10% in a single day, breaking through the $100 mark and reaching $105.6. It sounds exciting, but for Japan, it was a big headache—the Middle Eastern countries account for 95.9% of Japan’s crude oil imports, so soaring oil prices directly hit Japan’s import costs.

What impressed me most was the data comparison at that time. The exchange rate of the yen against the dollar had depreciated by 33% compared to the oil price peak in 2008, and in that month, the crude oil price in yen per barrel increased by about 9,500 yen compared to the previous month. This created a vicious cycle—rising oil prices pushed up Japanese inflation, and yen depreciation further increased import costs measured in yen.

The Bank of Japan was considering raising interest rates to curb prices. The yield on Japan’s 10-year government bonds once surged to 2.5%, hitting a 29-year high. But there was a paradox: Japan was facing imported inflation caused by supply shocks, and simply raising interest rates wouldn’t solve the fundamental problem. Moreover, if the central bank sharply increased rates in the short term, it could trigger a reversal of carry trades, posing a potential risk to the global economy.

The situation in the U.S. was also contributing to the pressure. In March, the CPI rose by 0.9% month-over-month, the largest increase since June 2022, with gasoline prices reaching a record high since 1967. This significantly lowered market expectations for a rate cut by the Federal Reserve this year, and funds flowed into the dollar as a safe haven, further depressing the yen.

At that time, Takahiko Nakao, a former senior foreign exchange official in Japan, pointed out that intervention in the forex market relying solely on foreign exchange reserves could only have short-term effects. To truly curb yen depreciation, the central bank must steadily raise interest rates in coordination with policy measures. But from the perspective of the yen’s outlook, achieving this coordination is not easy—Japan needs to combat imported inflation while avoiding rapid rate hikes that could trigger economic risks. The Bank of Japan was indeed caught in a dilemma.

From a technical perspective, the USD/JPY daily chart at that time showed a strong upward trend, with bulls eager to push higher. After breaking through the 160 level, there was a good chance of further testing the 163 level. To reverse the upward trend, the pair would first need to fall below 157.0.

Looking back now, this dilemma in the yen’s outlook reflects a bigger issue: in the context of global geopolitical instability and energy price volatility, the policy space for small central banks is actually quite limited. Japan’s situation is particularly typical.