Explainer-Japan intervenes in the currency market, now what?

© Reuters. FILE PHOTO: A man walks past the Bank of Japan building in Tokyo, Japan January 15, 2018. REUTERS/Kim Kyung-Hoon/File Photo

By Leika Kihara and Tetsushi Kajimoto

TOKYO (Reuters) - Japan intervened in the currency market on Thursday to buy yen for the first time since 1998, in attempt to shore up the hard-hit currency after the Bank of Japan stuck with ultra-low rates.

Below are details on how yen-buying intervention typically works as well as the challenges to that effort.

WHEN DID JAPAN LAST CONDUCT YEN-BUYING INTERVENTION?

Given the economy's heavy reliance on exports, Japan has historically focused on arresting sharp yen rises and taken a hands-off approach on yen falls.

Yen-buying intervention has been very rare. The last time Japan intervened to support its currency was in 1998, when the Asian financial crisis triggered a yen sell-off and a rapid capital outflow from the region. Before that, Tokyo intervened to counter yen falls in 1991-1992.

WHY IS YEN BUYING SEEN AS A RISK?

Currency intervention is costly and could easily fail given the difficulty of influencing its value in the huge global foreign exchange market.

That is one key reason it is considered a last-resort move, which Tokyo greenlights only when verbal intervention fails to prevent a free fall in the currency. The speed of yen declines, not just levels, are seen as crucial in authorities' decision on whether and when to step in.

Some policymakers say intervention only becomes an option if Japan faces a "triple" threat - selling of yen, domestic stocks and bonds - in what would be similar to sharp capital outflows experienced in some emerging economies.

HOW DOES IT WORK?

When Japan intervenes to stem yen rises, the Ministry of Finance issues short-term bills to raise yen which it can then sell in the market to weaken the Japanese currency's value.

In cases of intervention to prop up the yen, authorities must tap Japan's foreign reserves for dollars to sell in the market in exchange for yen.

In both cases, the finance minister will issue the final order to intervene. The Bank of Japan will act as an agent and execute the order in the market.

WHAT ARE THE CHALLENGES?

Yen-buying intervention is more difficult than yen-selling.

Japan's foreign reserves stand at $1.33 trillion, the world's largest after China's and likely composed mostly of dollars. While abundant, reserves could quickly dwindle if huge sums are required to influence rates each time Tokyo steps in.

That means there are limits to how long it can keep intervening, unlike for yen-selling intervention - where Tokyo can continue issuing bills to raise yen.

Currency intervention would also require informal consent by Japan's G7 counterparts, notably the United States, if it were to be conducted against the dollar/yen. That is not easy with Washington traditionally opposed to the idea of currency intervention, except in cases of extreme market volatility.