Japan’s Foreign Reserves Suffer Record Drop as Yen Intervention Intensifies

Reserves fall 6.18% in August as Tokyo's dollar-selling interventions and rising global bond yields weigh on holdings

Japan's foreign-exchange reserves recorded their sharpest monthly decline since comparable records began in 2000, falling 6.18% in August as Tokyo's efforts to support the yen coincided with a selloff in global government bonds.

Reserves stood at $1.207 trillion at the end of August, down from $1.287 trillion a month earlier, according to Finance Ministry data. The decline marked the fourth consecutive monthly drop and exceeded the previous record of 5.58% set in May.

The Finance Ministry did not specify the reasons for the latest decline. Kyodo News, citing an unidentified ministry official, attributed the fall to foreign-exchange intervention aimed at supporting the yen as well as a decline in the market value of government bonds following a sharp rise in yields.

Masahiko Loo, senior fixed-income strategist at State Street Investment Management, said the decline was primarily linked to Tokyo's recent efforts to sell dollars and buy yen.

"The decline is primarily the result of Japan's recent dollar-selling, yen-buying FX interventions," Loo told CNBC.

The drop in reserves provides a measure of the scale of Japan's recent currency-defense campaign. Tokyo has intervened repeatedly in foreign-exchange markets as the yen came under intense pressure from wide interest-rate differentials and expectations that U.S. rates would remain substantially above Japanese borrowing costs.

Japan spent about 11.73 trillion yen ($75.26 billion) supporting the currency in April and May before conducting a substantially larger intervention of 15.4 trillion yen at the end of July. The July operation was supplemented by the United States selling euros to support the yen, marking the first coordinated intervention between Washington and Tokyo to support Japan's currency since 1998.

The combined intervention of about 27.1 trillion yen so far this year is the largest annual amount recorded by Japan, exceeding the previous record of 20.4 trillion yen in 2003.

The intervention has nevertheless left the yen well below its levels of a year ago. The currency fell to a 40-year low of 163.98 per dollar on July 23 before recovering, and was trading around 155.98 on Monday.

For investors, however, the decline in reserves does not necessarily signal financial instability.

"The decline reflects policy action rather than financial stress," Loo said.

The latest decline largely reflects the government actively deploying foreign assets to influence the exchange rate rather than losing the ability to meet external obligations. At the same time, rising global bond yields are creating an additional valuation drag. Yields on government debt in the United States, Germany, Britain and other major economies have climbed to multiyear highs, reducing the market value of existing bonds held as reserve assets.

The combination creates a difficult environment for Japanese policymakers: defending the yen requires selling foreign-currency assets, while higher global yields can reduce the value of the assets that remain.

BOJ Rate Hike Bets Strengthen

The pressure on the yen is also strengthening the case for the Bank of Japan to raise interest rates.

Takuji Aida, an economic adviser to Prime Minister Sanae Takaichi and chief Japan economist at Credit Agricole, said the BOJ is likely to increase its policy rate in September and could continue raising rates roughly once a quarter through January.

Aida, a reflationist who has traditionally opposed rapid BOJ tightening, said he had brought forward his forecast for the next rate increase from January 2027 because September offers a narrow opportunity to act before an extraordinary parliamentary session begins in early October.

Parliament is expected to debate, among other measures, legislation related to Takaichi's proposal to suspend an 8% levy on food items for two years.

After a September increase, Aida expects another hike by January, followed by a slower pace of roughly one increase every six months.

"The premature, accelerated pace of rate hikes would weigh on the economy," Aida said.

Markets have already moved strongly toward expecting tighter policy. Investors are now pricing in a near-certain 25-basis-point increase in the BOJ's policy rate to 1.25% at its September 17-18 meeting.

The prospect of a hike has strengthened partly because of continuing pressure from Washington. U.S. Treasury Secretary Scott Bessent last week voiced strong support for "decisive" monetary-policy action by the BOJ to address yen weakness.

Japanese officials have pushed back against the perception that Washington can dictate monetary policy. Finance Minister Satsuki Katayama has repeatedly said interest-rate decisions are the responsibility of the central bank.

BOJ Governor Kazuo Ueda, however, said last week that policymakers would consider a rate increase, including at the September meeting, with particular attention to whether inflationary risks were intensifying.

Yen Weakness Puts BOJ In A Difficult Position

Analysts see the prospect of higher rates as an indication that currency intervention alone may not provide a durable solution to the yen's weakness. This is because selling dollars and buying yen can temporarily alter supply and demand in foreign-exchange markets, but the currency's longer-term direction is heavily influenced by interest-rate differentials and expectations for future monetary policy.

That leaves the BOJ facing a difficult balancing act.

Higher rates could make yen-denominated assets more attractive and reduce the incentive for investors to hold dollars against the yen. But faster monetary tightening would also increase borrowing costs for Japanese households and companies and could weaken domestic demand at a time when policymakers remain concerned about economic growth.

Aida's comments are therefore notable not simply because he expects a September hike, but because they suggest that support for further normalization may be broadening even within an administration that has generally favored accommodative policy.

The government has also been under pressure to prevent excessive yen weakness from feeding into imported inflation, particularly through higher energy and food costs.

For markets, the raging concern hangs on the ability of the BOJ to narrow the interest-rate gap with the United States without undermining Japan's economic recovery. The record decline in foreign reserves shows that Tokyo has been willing to use substantial resources to stabilize the currency. But with global bond yields rising and the yen still trading near 156 per dollar, intervention alone may have diminishing effectiveness.

A sustained recovery in the yen would likely require a combination of continued official intervention, a credible path toward higher Japanese interest rates and, potentially, a shift in expectations for U.S. monetary policy.