Germany will surpass Japan to become the third largest economy, with the weak yen as the main factor

Thanks to the yen's decline against the dollar and euro, the German economy is expected to replace Japan as the world's third largest economy in 2023. According to the latest forecast of the International Monetary Fund (IMF), Germany's nominal gross domestic product (GDP) this year is estimated to be US$4.43 trillion, and Japan's US$4.23 trillion.

The current exchange rate of the Japanese yen against the euro is approaching the 160 yen mark, and the exchange rate against the US dollar is only a stone's throw away from a 33-year low. The last time the yen hit 160 against the euro was in August 2008.

The weakness of the yen is mainly caused by fundamental differences in monetary policy. The Federal Reserve and the European Central Bank have been raising interest rates from pandemic lows to combat inflation, while the Bank of Japan remains in stimulus mode hoping to boost price growth after years of deflation.

While the Federal Reserve and the European Central Bank are expected to keep interest rates on hold at their upcoming meetings, borrowing costs are expected to remain elevated for longer, which could continue to weigh on the yen. The Bank of Japan will meet next week and there is speculation that it may adjust its controls on bond yields, but negative rates are widely expected to not end until next year.

But the data also suggest Germany's long-term growth will be more stable, giving Japanese policymakers something to consider as they consider the details of their latest economic package.

"Japan's economic growth potential has indeed fallen behind and remains sluggish," Japanese Economy, Trade and Industry Minister Yasunari Nishimura said on Tuesday when asked about the IMF forecast. "We want to regain the ground we have lost over the past 20 or 30 years and we hope to achieve this through measures such as the upcoming package."

Japanese Prime Minister Fumio Kishida said on Monday that the economic stimulus plan includes extending energy subsidies to ease the rising cost of living caused by Japan's strongest inflation in decades. He said steps would also be taken to ensure wage gains remain intact, along with some form of tax cut.

According to data from the International Monetary Fund, Germany's per capita gross domestic product (GDP) is expected to be US$52,824 and Japan's US$33,950.