Why is the yen so high against the pound?

The next five years should see Japan become a much cheaper holiday destination for Brits, writes Chris Towner of HiFX.

Buy one pound, get one free

The foreign exchange market is a ratio market that is constantly comparing currencies against one another.

The Japanese yen against the British pound is a classic example of the wild swings in the currency market over the past few years. Back in the summer of 2007 one could buy 250 yen for one pound.

However, going into 2012 that same pound could only buy 120 yen. In the spirit of seasonal sales, this means that the UK over the past few months has been running a ‘less than half price sale’ for the Japanese, whereas Japan has become twice as expensive for Brits travelling there.

What lies behind the exchange rate?

So why has the Japanese yen become so expensive? The Japanese yen has been cited as a safe haven in a credit crisis, helped by the low levels of personal debt that the Japanese have and their high savings rate.

On top of this, Japan has been running a current account surplus, and its banking sector experienced a crisis over a decade ago and is a lot more stable now.

The housing market is also very stable in Japan, as land value in Japan has pretty much dropped every year over the past two decades, and arguably prices in yen are starting to reach a bottom when compared with average earnings.

As for sterling, our over exposure to the financial sector, high levels of personal debt and inflated housing market made the currency particularly vulnerable when the financial crisis struck.

Sterling/yen outlook

It is somewhat bizarre to think that in a sovereign debt crisis the currency that is perceived as a safe haven has the largest debt-to-GDP ratio at over 200%.

The reason why it is not as exposed to the sovereign debt crisis is because the Japanese population funds its own debt, and relies on little more than 5% foreign money.

However, the future does not look so rosy for Japan. Not only has their debt got to levels where a return to no debt would take decades, but they also have a declining population, and therefore over time their reliance on foreign investors is going to increase.

The tables will turn

The outlook for the UK is that the timing of the last election allowed for hard decisions to be made to tackle the deficit. Although tackling a deficit is never an easy task, at least it is a viable challenge.

Therefore we expect Japan in the months and years ahead to become a cheaper place for Brits to visit. It's entirely possible that in five years' time Japan will be half the price for us Brits.