Japan’s currency will trade in the triple digits this year as a result of prime minister Shinzo Abe’s determination to end the country’s era of deflation, according to DBS Bank.
The yen is currently overvalued and will reach 102 against the dollar by the end of 2013, the bank forecast in a January 31 report authored by senior currency economist Philip Wee. DBS is cutting its outlook on the yen from a previous estimate of 87 against the dollar.
The bank also lowered its forecasts on the yen for the first quarter to 93 against the dollar from 84, 96 versus 85 in the second quarter, and 99 from 86 in the third quarter.
“Unlike his predecessors, PM Abe has been clear in his single-minded goal to end deflation. To achieve this, his cabinet will pursue more fiscal stimulus and adopt bold monetary easing, which in turn, would work together to weaken the yen without intervention,” wrote Philip Wee, senior currency economist for DBS in Singapore.
Japan’s currency rose to 90 against the dollar in the past two months, but Wee says Japan’s new leaders will allow the correction to continue until it reaches 110, which would be a level where they would start worrying about the yen being too weak.
The probability that the yen will be able to stay on a depreciating path will also depend on whether its trading partners will be willing to meet Japan halfway so that the risk of a currency war can be avoided.
The downgrade on the Japanese yen comes as Japan’s weak economic metrics do not provide enough justification for a stronger currency.
“Market participants, most of the time, cannot agree on much of anything. In the case of Japan, however, most would not disagree that the yen exchange rate is overvalued on weak fundamentals,” according to Wee.
Japan has struggled with record-wide trade deficits since the tsunami and earthquake that hit Japan in March 2011. Japan’s strained relations with China and the US is also problematic for the export-oriented country as global growth remains sluggish during the eurozone recession, according to Wee’s report.
Although real gross domestic product has recovered to pre-2008 crisis levels, nominal GDP has not because of deflation. Wee says a weak Japanese yen is only a natural consequence of the bold monetary policy and stimulus that will allow Japan to move out of deflation and boost nominal GDP.
“San Francisco Fed President John Williams did affirm in November 2012 that QEs prevented the US from falling into deflation. In this light, it is easier to understand why the Abe government sees the Bank of Japan (BOJ) playing a pivotal role in the fight to end deflation,” wrote Wee.
The Bank of Japan has doubled its inflation goal to 2% and open-ended asset purchases from 2014, while the government has approved a ¥10.3 trillion (US$114.4 billion) economic stimulus package to move out of deflation and jumpstart its economy.
The government has also set a target of achieving 2.7% in nominal GDP in fiscal 2013.
Wee expects the grand plan to end deflation to be a more medium-term strategy assuming that Abe stays in office longer than his predecessors, who did not last more than two years.