Is the Yen Going Into a Free-Fall?

Does the Yen’s Pullback Take the Heat Off Bank of Japan?
Akio Kon | Bloomberg | Getty Images

The rapid decline in the Japanese currency's value against the U.S. dollar, which touched a three-and-a-half-year low of 95.45 on Friday, has analysts wondering where to place their next bets.

The yen has weakened around 18 percent against the greenback since mid-November, just before elections in December that brought the ruling Liberal Democratic Party (LDP) to power as Shinzo Abe promised an aggressive monetary policy to revive the Japanese economy.

The nomination of Haruhiko Kuroda, known for his dovish views, as the new Bank of Japan (BOJ) Governor, has further compounded views that Japan will start its aggressive easing soon.

(Read More: Kuroda Signals Aggressive Monetary Policy Coming)

"There is a distinct lack of catalysts for halting the yen's decline this side of 100 [against the U.S. dollar]," said Nicholas Smith, Japan strategist at CLSA. He added that investors would have to first see the BOJ governor having a change of heart before seeing a reversal in the yen's slide.

"Kuroda has been very vocal in his promotion of quantitative easing for Japan for a dozen years. It's not very likely he would get out of bed one morning and say he'd changed his mind, but that's what some people seem to be counting on," said Smith.

Back in January, when the yen was trading at around 90 to the U.S. dollar, analysts were getting cautious on whether the Japanese currency would fall further on Abe's promise of radical economic changes. But two months on, the yen is trading at multi-year lows prompting some analysts to revise their forecasts.

Ray Attrill, global co-head of forex strategy at the National Australia Bank, said the yen's losses have led him to revise his forecasts. In January, he had said the yen would appreciate to the late 80s against the U.S. dollar by the end of the year.

(Read More: Is the 'Abe Trade' in Danger of Unwinding?)

But last month he revised that figure downwards to 95 by December and to 100 by next year. However, Friday's trade has upset these forecasts as well. "The risk is that a [U.S. dollar] move to 100 yen or higher is going to occur ahead of our forecast timeline," he added.

Switching on the Nukes

Analysts are now eyeing a particular political development that has the potential to halt the slide in the yen.

If the new Japanese government moved to reinstate nuclear power and therefore reduce Japan's reliance on external energy imports, this could strengthen the yen, they said. All but two of Japan's 50 reactors stay switched off after a huge earthquake and tsunami in 2011 triggered the world's worst nuclear disaster since Chernobyl at Japan's Fukushima Daiichi plant.

(Read More: Behind Nikkei's GainsIt's Not Just the Weak Yen)

"In the second half of this year Abe's intentions to restore nuclear power should work to narrow the trade balance and strengthen the yen," said Callum Henderson, global head of forex research at Standard Chartered. He forecast the currency weakening to 98 against the U.S. dollar by the end of the second quarter, but rebounding to 95 in the second half of the year.

CLSA's Smith agreed that "switching on the nukes" would boost Japan's current account balance, but said the impact was unlikely to come into effect until the year-end: "I fully expect to see the yen at 100 this year," he added.