Takaichi's High-Pressure Economy Fails to Boost Yen Amid Structural Headwinds

Japan's Prime Minister Sanae Takaichi has implemented large-scale tax cuts to stimulate demand and pursue a high-pressure economy. However, this approach may not be effective in addressing Japan's persistent supply-side constraints, such as unfavorable demographic trends and chronic labor shortages.

The Bank of Japan (BOJ) is facing pressure from financial markets to raise interest rates to combat yen weakness and rising long-term bond yields. The BOJ has raised the policy rate to 1.25%, its highest in 31 years, but this move may be constrained by Japan's high general government debt, which exceeds 250% of GDP.

The yen's weakness is also driven by structural factors, including a persistent current account deficit and a widening services-trade deficit, often referred to as the 'digital deficit'. Japanese companies are accelerating digital transformation, generating a steady stream of yen-selling demand for cloud computing, software services, and digital advertising. Additionally, foreign direct investment flows largely outward, with little natural demand to convert foreign profits back into yen.