As if the yen doesn’t have enough reasons to weaken, risks are emerging that higher oil prices will hit energy import-dependent Japan and its currency. 

Crude oil futures jumped on Friday following reports that Israel launched a missile strike on Iran, extending their gain to more than 25% from a December low. The prospects of heightened tensions in the Middle East suggest the rally may have room to run.

That’s bad news for yen bulls: a 10% gain in oil prices will help pull down the currency by 3 to 4 yen against the dollar on an annual basis, according to estimates by Yujiro Goto, head of Japan currency strategy at Nomura Securities Co.

While the yen climbed initially on Friday amid flight to safety, it subsequently pared the gains. The currency has been dragged down by the wide yield gap between Japan and other major economies such as the US, and expectations that the Bank of Japan will raise interest rates only modestly while a Federal Reserve cut may be delayed.  

“Japan is totally dependent on imports for oil, so price increases lead to higher energy bills, the result of which can be seen in a weaker yen,” said Tsutomu Soma, a bond and currency trader at Monex Inc. in Tokyo. “Although rising oil prices are associated with higher inflation, it’s unlikely that the BOJ will rush to raise interest rates, so the rate differential will remain in place.” 

A shortfall in the nation’s trade balance has persisted since 2021 on a seasonally-adjusted basis, along with surging energy imports. Mineral fuels including oil, natural gas and coal make up about a quarter of the nation’s total imports, based on data from the Ministry of Finance.

The weak yen has failed to give Japan export competitiveness, with a gauge for inflation-adjusted overseas shipments stuck in a narrow range for three years. Investors are also parking more of their funds in higher-returning foreign securities, while businesses are investing more abroad, keeping in deficit Japan’s basic balance — a broad measure of capital flows.

In a sign of growing concern over external deficits, the Ministry of Finance is holding a series of meetings with academics and market watchers to discuss desirable policies to overcome those issues.

The yen strengthened 0.2% to 154.37 per dollar as of 1:33 p.m. in Tokyo. It has lost 25% since the end of 2021 as the Fed tightened policy aggressively to rein in inflation. US Treasury Secretary Janet Yellen this week acknowledged the concerns of Japan and South Korea over sharp declines in their currencies.

“The source of the yen’s weakness is the strength of the dollar from the exceptional resilience of the US economy and the markets pulling back Fed cut bets on sticky US inflation,” said Philip Wee, a senior FX strategist at DBS Bank Ltd. in Singapore. “The Middle East situation adds fuel to the fire by fanning fears of another oil price spike returning the Fed to hiking rates again.”

Energy Dependence

The high import bill partly comes from Japan’s decision to halt most of its nuclear power plants following the 2011 Fukushima disaster. Japan has a target for nuclear to account for as much as 22% of the power mix by 2030 from less than 10% now.

Net energy imports — the difference between imports and exports — stood at 85% of power consumption, according to Bloomberg calculations using the latest figures from the International Energy Agency. This is the highest among major economies and stands in a stark contrast with the US’s status as a net energy exporter.

“It is inevitable that the handling of mineral fuels will be emphasized as national policy” because adjusting the power mix can lower imports, Daisuke Karakama, chief market economist at Mizuho Bank Ltd. in Tokyo, wrote in a research note on Wednesday. “That would deliver the most immediate effect as a measure against the yen’s depreciation.”