UBS warns: Yen may fall to 175, intervention will only "exhaust foreign exchange reserves but fail to reverse the trend"

Why does rising oil prices make yen intervention measures seem even less effective?

Source: Jin10 Data

Strategists at UBS Group AG believe that even if Japanese officials increase their intervention rhetoric, the yen’s decline will continue, and they expect that in a “long-term turmoil” scenario, the USD/JPY(159.46, 0.6700, 0.42%) exchange rate will reach 175 by the end of the year.

The group’s strategist Shahab Jalinoos and others stated in a report released on Wednesday that if oil prices rise to $150 per barrel, “attempting to control inflation through foreign exchange intervention may instead give the market a higher level at which to sell the yen, ultimately depleting foreign exchange reserves without necessarily changing the exchange rate trend.”

They added that efforts to curb inflation may rely more on fiscal measures such as energy subsidies.

In this scenario, the market might believe that in a global stagflation environment, Japanese policymakers have no intention of preventing the yen from weakening, and the resulting trade shocks will drive the USD/JPY significantly higher.

As this forecast was released, the USD/JPY exchange rate broke above 160 last Friday for the first time since 2024, prompting increasingly stern warnings from policymakers. Japan’s top foreign exchange official, Masamura Jun, signaled the possibility of taking “bold action,” while Bank of Japan Governor Ueda Kazuo reiterated that exchange rate movements are a factor influencing policy. Finance Minister Shunichi Suzuki also said Japan is prepared to take countermeasures, highlighting the country’s high alertness to further yen depreciation.

The war between the US and Iran has added new pressure on the yen. Japan relies almost entirely on energy imports, with over 95% of its oil imports coming from the Middle East, making it highly vulnerable to disruptions in the region. Rising oil prices mean Japan must pay more for energy imports, increasing demand for foreign exchange and leading to yen depreciation.

Structural factors continue to play a role as well. Japan’s ultra-low interest rates, combined with the interest rate gap with the US and other major economies, still encourage investors to borrow yen cheaply and invest in higher-yielding overseas assets, exerting ongoing downward pressure on the yen. Although the Bank of Japan raised interest rates to their highest level in 30 years in December last year, by global standards, rates remain relatively low.

Over the past decade or so, yen depreciation has helped Japan become an affordable travel destination for millions of foreign tourists and boosted profits for its largest exporters. However, in an economy heavily dependent on imported energy and raw materials, a weak yen also raises costs, fuels domestic inflation, and squeezes corporate profit margins. The resulting cost-of-living squeeze has contributed to the resignation of two previous prime ministers before current leader Sanae Sato took office.

Beyond domestic factors, there is another reason why the Japanese government might want to act. US President Trump has repeatedly criticized Japan’s weak currency, claiming it gives Japanese manufacturers an unfair trade advantage. This issue has been raised in trade negotiations between the two countries. US officials are sensitive to excessive yen weakness. In January, the New York Fed contacted financial institutions to inquire about the USD/JPY exchange rate, which subsequently triggered a sharp rebound in the yen.