Japan just put a 'Band-Aid' on the yen. Why high oil prices could soon rip it off.

By Isabel Wang

Concerns about high oil prices are adding to inflation fears in Japan, as the BOJ just moved to rescue the yen from a roughly 40-year low

Why Japan's recent intervention to boost its weak currency is like putting a Band-Aid on a wound that needs stitches, according to analysts

A rare move by Japan to support its currency on Thursday helped rescue the yen from its weakest level in about 40 years - but high oil prices brought on by the Iran war are hindering the chances of a stronger recovery.

The Japanese yen (USDJPY) this week held a critical line against the U.S. dollar, after Japan's government and the Bank of Japan reportedly carried out an estimated $35 billion currency intervention for the first time in two years. The yen settled at 157.07 per dollar on Friday afternoon, after surging 2.4% on Thursday for its biggest one-day gain since January 2023.

For the week, the yen strengthened 1.5% against the dollar and logged its best week since Feb. 13, according to Dow Jones Market Data.

The rebound came after the Japanese currency earlier this week weakened to over 160 per dollar - one of its lowest levels in over 40 years, and a critical threshold that appears to have forced Japanese authorities to step in to buy yen while selling the greenback.

"The intervention did its job in terms of defending the 160 level for the yen," said Eric Wallerstein, chief macro strategist at Clocktower Group. "But it's like putting a Band-Aid over something that requires a suture," he noted, as Japan faces two sources of inflationary pressure hitting at the same time: its weaker currency and the Iran war.

The relationship between yen and global oil prices runs both ways. Japan imports roughly 90% of its oil from the Middle East and pays for it in the U.S. dollar DXY, so a weaker yen amplifies the cost of buying oil in local currency. Rising global oil prices also weaken the yen, since Japan needs more dollars to pay its import bills. The dollar's safe-haven appeal has also deepened the yen's weakness.

As a result, a stronger yen may require more than a strategically timed currency intervention from the Japanese government. It likely also needs interest-rate hikes and lower oil prices to cooperate, according to market analysts.

Japanese Prime Minister Sanae Takaichi "wants to keep rates low to help her stimulative, fiscally loose agenda," Wallerstein told MarketWatch. "She's hoping that market intervention can manage the yen, mitigate inflation and ostensibly also mitigate oil directly, but rate hikes would quite literally fix both of these issues at once," he said in a phone interview Friday.

Inflation in Japan accelerated for the first time in five months in March, as the Iran war fueled a 60% jump in global crude prices. The Bank of Japan earlier this week held its short-term policy rate steady, with BOJ Governor Kazuo Ueda refraining from providing a clear signal on the timing of the next rate move.

That uncertainty has cast doubt on the future strength of the yen on Wall Street. Citigroup strategists on Friday said they had decided to sell their "short USD/JPY position" and take profits following Japan's currency intervention, as elevated oil prices may still pressure the Japanese currency. Being short USD/JPY means investors are betting that the dollar will fall in value against the yen, or that the yen will strengthen against the greenback.

"Intervention only works as a bridge to changing fundamentals," wrote the team of Citigroup strategists led by Dirk Willer, head of global macro strategy and asset allocation. "The reflation trade has made a comeback in recent weeks due to the war in the Middle East. Going forward, the risk is that a higher-for-longer oil regime continues to fuel reflation fears."

Japan's core consumer prices, which excludes fresh food, rose 1.8% in March from a year earlier - still slightly below the 2% target set by the Bank of Japan, yet historically elevated for an economy that spent decades battling deflation or near-zero inflation.

Steve Englander, head of global G-10 FX research and North America macro strategy at Standard Chartered Bank, said it's not particularly surprising that the yen reacted so sharply this week following the intervention, especially given the lower liquidity in Asian markets during Golden Week holidays.

"If I spent $35 billion in the FX market, I would move [the market] too. The question is how many times I can do it," Englander told MarketWatch via phone. "What's interesting is that Japan did it during a very low-liquidity week, so threatening to intervene when markets are thin, in theory, should give you a bigger spot bang for the buck."

Japan is now considering stepping into oil futures markets, according to a Bloomberg News report. The idea is to relieve pressure on the yen, with policymakers viewing the surge in energy prices as a key driver of the currency's weakness against the dollar.

Global and U.S. oil futures fell as the yen strengthened on Friday. U.S.-traded West Texas Intermediate crude saw its June contract (CL00) (CLM26) fall 3% to $101.94 a barrel, while global benchmark Brent crude futures for July delivery (BRN00) (BRNN26) were off 2% to $108.17 a barrel, according to FactSet data. Earlier in the week, Brent briefly hit $125 a barrel, the highest level since the Iran war began.

The Embassy of Japan in the U.S. and the Ministry of Finance in Japan did not immediately respond to MarketWatch requests for comment.

"It would be misguided to think that they could actually suppress the price of oil," said Wallerstein. "Maybe you can jawbone the level of your own currency, but you are not going to be able to do so in terms of global oil markets - especially when the Iran conflict isn't something Japan owns."

-Isabel Wang

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05-02-26 0730ET